RMPG Learning Series CRM Workshop Day 2 session 1

1,143 views

Published on

This is being made available for Risk Management Practice Group on Linkedin.

RMPG Learning Series CRM Workshop Handouts: File 4 of 9

Published in: Economy & Finance
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
1,143
On SlideShare
0
From Embeds
0
Number of Embeds
5
Actions
Shares
0
Downloads
38
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

RMPG Learning Series CRM Workshop Day 2 session 1

  1. 1. Agenda for Day 2 Financial & Ratio Analysis Subjective Analysis Lunch Break Case Studies Open Session/ Q&A IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 1
  2. 2. Context of today’s discussion Analysing financial statements is the starting point for credit risk assessments, and at times, it is the core of an assignment Therefore a sound grasp of financial terminology and presentation is required Also, one needs to understand which figures to use; where to find them; and how to judge the result IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 2
  3. 3. Fundamental accounting concepts A company is a legal entity - it own assets and liabilities Money qualification If it is impossible to place a monetary value on a transaction it cannot be recorded in the books of account New concepts - human asset accounting, brand value, etc Fixed asset valuation Fixed assets are generally shown at their historic cost less depreciation They are not shown at their scrap or resale value Going concern There is no attempt in the balance sheet to set out the current market value or disposal value of assets Assets are valued on the basis of the going concern assumption IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 3
  4. 4. Fundamental accounting concepts Prudence rules When in doubt take the lower of two values e.g., cost or market value; When in doubt write it off. For example, inventory should be valued at the lower of cost or market value; potential bad debts should be written off immediately, not when all hope of collecting the money has evaporated; if there are any doubts about revenue receipts recognise it only when it is collected in cash; include only profits in the income statement that have been realised during the year; it is not prudent to anticipate events; take care to provide for all known or anticipated liabilities and losses to date, although not to the extent of creating hidden reserves; recognise future losses as soon as they are known, not when they happen IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 4
  5. 5. Fundamental accounting concepts Realisation Until an event or transaction has actually taken place it should not be taken into account in arriving at the profit or loss for the year A customer’s promise for a large order is not a transaction Increase in asset values cannot be treated as profit unless sold Accrual and matching Income and expenditure should be included in the income statement at the time the transaction or event took place, which is usually when it is invoiced, not when the cash relating to the transaction is received or paid. E.g., Advance cannot be regarded as income The income statement shows the revenue generated during the year and matches it with the costs and expenses incurred in producing it. E.g., adjustment for accretion or depletion to stocks IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 5
  6. 6. Fundamental accounting concepts Consistency Policies should not be changed frequently Profits can be increased or decreased by change in accounting policies, e.g., inventory valuation or depreciation Materiality Whatever is material should be disclosed IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 6
  7. 7. Annual Accounts - looking at detailed heads LIABILITIES 31-Mar-01 31-Mar-10 31-Mar-00 31-Mar-09 Equity Share Capital 561.50 561.5 Capital Reserve 2.00 0.00 Share Premium Reserve 0.00 0.00 General Reserve + P & L A/c 3556.28 1651.59 GROSS RESERVES 3558.28 1653.29 Less: Miscellaneous Expenditure NET RESERVES 3558.28 1653.29 TANGIBLE NET WORTH 4,119.8 2,214.8 Preference Share Capital 250.00 250.00 Debentures Rupee Term Loans 4405.18 3344.72 Deffered payment credit 0.00 0.00 Other deposits ( trade) 74.25 102.51 TOTAL LONG TERM DEBT 4,761.6 3,731.6 IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 7
  8. 8. Annual Accounts - looking at detailed heads Bank Borrowings 2238.81 1223.14 Commercial Paper Fixed Deposits Intercorporate Borrowings Loans & Advances from Subsidiaries Loans & Advances from Affiliate Cos Short Term Loans from Bank & FIs 1965.40 0.00 TOTAL SHORT TERM DEBT 4,204.2 1,223.1 Creditors for Goods 622.31 556.28 Creditors for Expenses Interest Accrued but Not Due 26.85 11.62 Other Current Liabilities 4.50 2.59 TOTAL OTHER LIABILITIES 675.1 594.9 Provision for Dividend 3.31 112.30 Provision for Taxes Provisions for prefrence dividend 32.50 Provision for dimunition in value of investments TOTAL PROVISIONS 35.8 112.3 IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 8
  9. 9. Annual Accounts - looking at detailed heads ASSETS 31-Mar-01 31-Mar-10 31-Mar-00 31-Mar-09 Gross Block 2478.5 2145.0 Gross Block 2478.5 2145.0 Less : Accumulated Depreciation -437.0 -655.7 Net Block 2041.4 1489.3 Capital Work in Progress 366.3 176.7 NET FIXED ASSETS 2407.7 1665.9 Investments in Subsidiaries 214.1 214.1 Investments in Affiliate Companies 0.0 0.0 Other Investments 0.4 0.3 TOTAL INVESTMENTS 214.5 214.4 IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 9
  10. 10. Annual Accounts - looking at detailed heads Raw and Packing Materials 1236.2 760.6 Work-in-Process 549.0 498.9 Finished Goods 2243.4 1098.9 Stores and advertising materials 397.7 364.4 TOTAL INVENTORIES 4426.3 2722.8 Receivables (More than 6 months) 90.7 31.1 Receivables (Less than 6 months) 4060.9 1173.6 TOTAL RECEIVABLES 4151.5 1204.6 Loans & Advances to Subsidiaries Loans & Advances to Affiliate Companies Advances Recoverable in Cash or kind 1683.5 1243.4 Advances to group companies/ property purchase Cash and Bank Balances 93.1 38.8 Interest Accrued on deposits and investments Deposits with others 798.0 785.4 TOTAL OTHER ASSETS 2596.5 2069.1 IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 10
  11. 11. A sample Profit & Loss Account For the year ended 31-Mar-01 31-Mar-09 31-Mar-10 31-Mar-00 Sales receipts 21,009.4 14,718.5 Other Sales Less : Excise duty (223.7) (365.9) Net Sales 20,785.7 14,352.6 Other Related Income OPERATING INCOME 20,785.7 14,352.6 Material costs 12,242.7 6,813.8 Traded goods purchased Accretion/ Decretion to stocks (1,194.6) (491.2) Consumable stores 18.4 16.6 Power and fuel 70.6 43.9 Employee costs 769.4 542.3 Other manufacturing expenses 251.4 144.7 Other expenses 505.2 382.7 Selling expenses 5,253.2 4,913.7 Miscellaneous Expenses Written Off Less : Expenditure Capitalised COST OF SALES 17,916.3 12,366.5 OPERATING PROFIT BEFORE DEP 2,869.4 1,986.1 IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 11
  12. 12. A sample Profit & Loss Account OPERATING PROFIT BEFORE DEP2,869.4 1,986.1 INTEREST AND TAX Interest and Finance Charges 846.0 457.2 OPERATING PROFIT BEFORE DEP 2,023.4 1,529.0 AND TAX Depreciation 101.9 105.5 OPERATING PROFIT BEFORE TAX 1,921.6 1,423.5 Non - operating Income 142.1 361.8 Other Adjustments (0.2) 0.23 Extraordinary Income 0.0 0.0 Extraordinary Expenses 0.0 0.0 ADJUSTED PROFIT BEFORE TAX 2,063.5 1,785.5 Tax 0.0 80.0 ADJUSTED PROFIT AFTER TAX 2,063.5 1,705.5 Dividend - Equity 128.0 129.1 Dividend - Preference 32.5 32.5 ACCRETION TO RESERVES 1,903.0 1,544.0 NET CASH ACCRUALS 2,004.9 1,649.5 IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 12
  13. 13. Important areas to focus upon Operating profit before interest, depreciation and tax It is positive or negative? Profit is not cash - check the debtors figures Trend Depreciation Straight line method Reducing balance method Accelerated depreciation method or sum of digits method (5/15, 4/15…for a 5 year assets) Each method will result into different depreciation figures for each year Check if there is any change in policy IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 13
  14. 14. Important areas to focus upon Interest Is it netted with interest received? Has interest been capitalised? What is the amount of capitalised interest? Has implications on interest coverage ratio Tax Is actual tax paid rate different than the standard rate? Deferred taxation Is the company claiming depreciation benefit?…leads to apparent distortion in the reported after-tax profits due to timing differences IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 14
  15. 15. Analysis of financial statements is necessary to gauze thefinancial health of a borrower Method of Analysis: Percent of Sales method Trend analysis Ratio analysis Funds flow analysis Cash flow analysis Break even analysis etc IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 15
  16. 16. Ratio Analysis Most important generic ratios of relevance in credit analysis Liquidity ratios / indicators Gearing levels Profitability ratios Leverage ratios Coverage ratios Return on Capital / Investments / Assets Turnover / Holding ratios (Activity) IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 16
  17. 17. Applicability of Financial Analysis Financial analysis should be uniformly applicable to all accounts This analysis should be uniformly applicable to all borrowers irrespective of nature of business i.e. both Manufacturing Trade and Services IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 17
  18. 18. To ensure comprehensive financial analysis, examine thefollowing additional financial indicators Profitability : Gross Profit: PBDIT [change current formula] Gross Profit Margin: PBDIT/ Sales [change current formula] Return on Capital Employed (ROCE) Efficiency Ratio : (Inventory+Receivable)/ Sales Fixed Assets Turnover Coverage Ratio : Debt Service Coverage ratio for all term loans Solvency Ratio : Total Debt/ Tangible Net Worth Cash Flow Based Analysis : Cash Interest Coverage Cash DSCR IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 18
  19. 19. Trend analysis and comparison with peers will provide furtherinsights into the performance of the entity…1 Sales Analysis Causes for growth/decline in sale Composition of future sales Compare company growth rate with industry growth rate Impact of growth on profitability and liquidity Profitability analysis Whether profitability parameters are comparable with the peers Causes for changes in profit margins ( NPM/GPM), ROCE & RONW. IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 19
  20. 20. Trend analysis and comparison with peers will provide furtherinsights into the performance of the entity…2 Liquidity Analysis Analyse reasons for variation in current ratio Analyse reasons for change in NWC/Sales Efficiency Analysis How efficiently is company in managing inventory, account receivables and creditors as compared to peer group? Analyse fixed assets turnover ratio as it indicates capital intensity and vulnerability to business volatility. Coverage Analysis Conduct sensitivity analysis to estimate whether DSCR is adequate to cover loan obligation Leverage Analysis Compare TOL/TNW & Total Debt/TNW of the company with peer group IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 20
  21. 21. Cash Flow and sensitivity analysis should be a must forLarge Corporate Loans Cash flow analysis will reveal Questions: Is the business generating enough cash to meet its loan obligation? What were the major sources of cash? How were the cash inflows used? Objective:•Sensitivity analysis will provide further insights into the operations of the company Identify the key risk factors that could impact the performance of the firm What would be the impact of changes in these risk factors on financial position of the firm? Set limits for risk factors during sensitivity analysis and build it into the loan covenants for monitoring the performance of the account IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 21
  22. 22. Case Study: Cash flow analysisFinancial Position (Rs. Lacs) 2007-08(A) 2008-09(A) 2009-10 (E) Net Sales 859.3 964.5 1012.0 Net Profit 17.3 14.4 16.0 Current Ratio 1.3 1.3 1.5 Cash Accruals 48.4 47.9 47.5Would you lend to the client? Net Cash after Operation 57.7 35.9 -6.9 Cash Interest Coverage 1.7 1.3 -0.3 IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 22
  23. 23. Financial Ratios Growth Profitability Liquidity Leverage Coverage Efficiency IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 23
  24. 24. Growth - how it affects credit risk Importance of growth in assessing credit risk Growth is essentially measured by increase in revenues over previous year. Growth in revenue is the basic driver for increase in profits and value of a firm Growth in revenue is a measure of the ability of the borrower to maintain market share. Growth needs financial resources (most of the time), and banks need to assess the appropriate level of financing for a given growth Watch points Too much of growth in revenues is not necessarily good Growth needs to be assessed in conjunction with margins and cash flow Inadequate financing (especially for small companies) could be dangerous IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 24
  25. 25. Profitability Importance of measuring profitability for risk analysis Profit is a measure of efficiency of operations and finance in a business Profitability can be measured in more than one way - what is relevant? Watch points Profitability measure has to be measured against an appropriate benchmark (e.g. industry average, Cost of capital) Profit is not cash flow IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 25
  26. 26. Leverage - the reason for a bank’s business, and themain cause for default Importance of leverage An indicator of financial risk of a borrower Watch points How to define leverage? - total borrowings only or should we include other liabilities? Understanding net worth IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 26
  27. 27. Liquidity - the determinant of short term solvency Importance What is the ability of a borrower to meet its obligations in the short run, usually one year? Theoretically, higher the current/ acid test ratio, the greater is the short-term solvency Watch points A higher current ratio or acid test ratio does not necessarily mean a good thing IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 27
  28. 28. Case Study: Liquidity analysis Financial Position (Rs. Lacs) 2007-08(A) 2008-09 (A) 2009-10 (E) Net Sales 859.3 964.5 1012.0 Gross Profit 80.7 76.6 73.0 Gross Margin (%) 9.4 7.9 7.2 NWC 217.2 229.2 283.6 NWC/Sales(%) 25 24 28 Change in NWC/Sales(%) -1 4 Current Ratio 1.3 1.3 1.5 Inventory Days 68 66 67 Debtor Days 71 70 83 Is liquidity position improving? IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 28
  29. 29. Cashflow - Cash is king Importance of cash flow Need to measure how much cash flow does a firm generate internally from operations Internal cash flow generation turning negative is the first sign of operating distress, particularly if it recurs Internal cash flow is a combination of three parameters - sales growth, operating profitability and working capital intensity Watch points Internal cash flow measures need to be interpreted in conjunction with leverage and working capital requirements and measures of financial flexibility of firm IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 29
  30. 30. Coverage Importance of coverage indicators Coverage indicators point to debt servicing ability of a borrower. Low coverage parameters indicate higher dependence of the borrower on external sources of funds to meet its interest commitments Good predictors of default Watch points Historical DSCR is prone to lumpiness of principal repayments Coverage should be assessed from a cash perspective IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 30
  31. 31. Sales Growth• Weighted average of the companies growth in operating income over the last two years.• The non montonicity displayed in the curve is very strong and very intuitive• Low sales growth imply high risk (weak prospects)• High sales growth imply high risk (firm is rapidly expanding most likely because of additional financing and the future would not be as good as the current year) 100% 90% 80% Default Frequency 70% 60% 50% 40% 30% 20% 10% 0% -1 03 06 1 15 19 25 3 32 52 5 5 0 0. 0. .2 .1 0. 0. 0. 0. 0. 0. 0. -0 -0 Sales Growth IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 31
  32. 32. Gearing ratio Indicates stability TOL / TNW Debt Equity ratio (TTL / TNW) Gearing ratio - Stability TOL TOL TNW TNW Stable Unstable IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 32
  33. 33. Gearing • Computed as the ratio of the borrowers Total Debt to his Tangible Networth • The higher the gearing the more leveraged a borrower is and the lesser cushion he has for adverse circumstances 100% 90% 80% Default Frequency 70% 60% 50% 40% 30% 20% 10% 0% 00 15 40 62 90 10 30 70 90 40 40 00 50 0. 0. 0. 0. 0. 1. 1. 1. 1. 2. 3. 5. 7. Gearing IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 33
  34. 34. Interest Coverage • Computed as the ratio of the borrowers Operating Cash flows available for servicing interest • An indication of the comfort that he has in servicing his debt obligations 1.20 1.00 Default Frequency 0.80 0.60 0.40 0.20 0.00 -3 1.2 2.4 3 5 7.5 -10 0.06 0.18 0.57 0.81 1.27 1.55 1.85 3.75 Coverage IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 34
  35. 35. Important Coverage ratios Debt Service Coverage ratio = PAT+ Depn+ Amortisation+ (INTT) Loan Repayment + (INTT) Interest Coverage ratio = PBDIT InterestDSCR measures ability to service debt of the borrower.DSCR should be calculated for all borrowers irrespective of Source of Term Loan Type of Loan IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 35
  36. 36. PROFITABILITY RATIOS Gross Profit ratio = GP/Sales Net Profit ratio = PAT/Sales Operating Expense ratio = OE/Sales ROCE = PBDIT/Total Capital Employed EPS = PAT/No of shares PE Ratio = MV/EPS IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 36
  37. 37. Case Study: Coverage analysisFinancial Position (Rs. Lacs) 2007-08(A) 2008-09(A) 2009-10 (E) Net Sales 15069.3 16150.5 14255.9 Interest 1093.3 1021.6 923.6 EBIT 1629.8 1647.6 1071.9 Debt/TNW 1.4 1.2 1.6Would you lend to the client? IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 37
  38. 38. Return on Capital Employed • ROCE – PBIT to the Average capital employed • Better ROCE would improve the value of equity, indicate better firm prospects and also imply more cushion against losses 100% 90% 80% Default Frequency 70% 60% 50% 40% 30% 20% 10% 0% -1.5 -0.2 -0.1 0 0.05 0.1 0.15 0.2 0.29 ROCE IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 38
  39. 39. Du Pont Analysis Du Pont pyramid of ratios To get an understanding of not only the level of a company’s profitability but also how the profit is being made A B Sales 300 100 PAT 25 40 Assets 125 200 RoA 20% 20% Both A and B have a 20% return. What conclusions can be drawn? Introduce the asset or capital turn To form a view on the company’s efficiency in the use of its assets or capital Asset turn = Sales divided by Assets Capital turn = Sales divided by Capital IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 39
  40. 40. Du Pont Tree IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 40
  41. 41. Free Reserves to Equity • Free Reserves – Adjusted for free reserves not coming out of internal earnings • Equity – Paid up capital • An indication of the financial resilience of the borrower in face of downturn and historical profitability 100% 90% 80% Default Frequency 70% 60% 50% 40% 30% 20% 10% 0% -10 -3 -1 0.25 0.75 1.25 2.5 3.5 4.5 6.5 9.5 10 14 Free Res erves / Equity IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 41
  42. 42. Liquidity Indicators Current ratio Acid test / Quick ratio NWC (Net Working Capital) Cash Generation IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 42
  43. 43. Quick Ratio• Quick assets to quick liabilities - A measure of Short-term liquidity. A higher proportion shows greater net current assets available for meeting current liabilities• Quick assets shows no clear relation to default based on the database• Consequently the QR impact on the model is based on a subjective notch up/ down to the financial score based on management score and QR value 90% 80% 70% Default Frequency 60% 50% 40% 30% 20% 10% 0% 0 0.25 0.5 1 1.1 1.4 1.6 1.8 2.3 2.45 2.8 3.2 Quick Ratio IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 43
  44. 44. Important Ratios and Benchmark IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 44
  45. 45. Qualitative Financial Risk Drivers Retention of Profits Access to Credit in Other Banks Accounting Quality Ranking of Auditor Restructuring History IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 45
  46. 46. Important ground rules Analysing a company’s profitability without any reference to its financial position is of little value Never judge a company on the basis of one year’s figures. Always look at three or ideally, five years’ figures Never judge a company in isolation. Always compare its performance with others of the same size and/or the same business sector and/or Country When comparing companies always make sure, as far as you can, that you are comparing like with like - in other words, that the basis of the data being analysed is consistent IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 46
  47. 47. Financial Ratios…important points to rememberConsistencyNever rely on a single ratioAccounting periods IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 47
  48. 48. Financial Ratios…important points to rememberDon’t forget to annualiseAverage, median or mode?Investigate variations IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 48
  49. 49. DISCUSSIONS IM aCS 2010 Printed 11-M ay-11For Classroom discussion only Page 49
  50. 50. All the contents of the presentation are confidential andshould not be published, reproduced or circulated without the written consent of IFC, Bangladesh Bank and IMaCS. IM aCS 2010 Printed 11-M ay-11 For Classroom discussion only Page 50

×