Credit Analysis: Financial, Ratio, and Risk Analysis

Abstract

Credit analysis involves a wide variety of financial analysis techniques including ratio and trend analysis, of audited and unaudited financial statements. Credit Analysis also entails the creation of future projections and detailed analysis of cash flows, as well as the analysis of previous credit history, company history, collateral, and repayment methodology. The basic concepts mentioned here are the foundation to obtaining empirical information on a company to measure its creditworthiness. Preceding any sort of loan disbursement to a corporation, small or large, a credit analyst must provide a thorough and concise analysis of the company's financial history, focusing mainly on their cash flows. The analyst will measure the company's cash flow before any sort of interest, taxes, depreciation, and amortization, also known as EBITDA. EBITDA, or earnings before interest, taxes, depreciation, and amortization is a measurement tool used by all banks, when analyzing the possible disbursement of a line of credit. For example, EBITDA may be used as a precursor tool to the initial analysis, however failure to include the left out expenses of interest, taxes, depreciation, and amortization in later analysis, may in fact sway the analyst into believing that the company is financially sound, creating a very hazardous and high risk situation for the bank itself. Failure to acknowledge these factors may result in large capital losses and possible residual incompetency of the bank. In later analysis of a company it is important to analyze their financials including all expenses, divestitures, and acquisitions. When including these three things, among other in-depth analysis, it is then possible to write a thorough proposal to a company whether it is a renewal or new extension of credit. The analyst may find that even though the company has a very stable financial history; it may have incurred too many expenses in order to continue fully financing the loan according to the amortization schedule, or it may not have the liquid capital at the moment to take on a new credit in which they have requested. Finally, the analysis that is provided will also be used as a risk measurement tool for all banks extending a line of credit to a company herein. All banks are different in their policies about the risks in which they are willing to take, but the majority of risk in which the banks are willing to incur is commensurate upon their present financial situation.