Credit Analysis for Bankers
Here is a sample format for bankers and credit professionals to prepare a credit analysis on a commercial borrower. It should be taken as just a sample and adjusted for your specific needs. This format provides a consistent, systematic and flexible basis for analyzing credit requests and relationships. It helps to identify risks and identifies the ability to service debt. Our Evaluating Financial Statements section provides a practical/detailed primer on financial statement analysis.
Section I: Company Overview
The company overview is prepared as a permanent addition to the credit file. It provides detail on the business, industry, organizational structure, historical sources of financing, significant accounting practices and management.
Date of Analysis:
Name of Analyst:
What is it that this analysis will cover, i.e. To review XYZ; to extend line of credit.
Type of loans, relevant terms, covenants, clean-up requirements, key-man life insurance, etc.
Transaction Summaries should be used for complicated deals.
This section is used to describe all non-financial factors relating to the business. Included are subsections on:
When and where it was started; major events in the company evolution.
Nature of the Business:
This section should address:
Product lines or services
Terms given to customers
Customer base, if there are large concentrations
Fixed asset requirements
The present legal form (proprietorship, partnership, corporation, LLC)
Principal owners and their percentage of ownership
Tax structure if not apparent from legal form (S-corp status vs. C-corp)
Major organizational units (divisions, subsidiaries, etc.),
and relationships with affiliates, parent company or subsidiaries.
This section includes information on key managers, including:
Name, title and functional position of key players
Management background, education, experience, competence, years with company, legal issues, other commitments (side businesses)
Evaluation of the adequacy of management succession
Management goals (growth oriented, service oriented, etc.) and strategies (acquire fixed assets, price aggressively, introduce a new product line, seek equity funding, etc.)
It is important for the analyst to work closely with the loan officer when evaluating management. Questions like: How stable is management? Has there been a change in philosophy? Have they provided a business plan? Is it realistic? Is the management team aggressive or conservative? These questions should be addressed with the loan officer or the management team directly, if appropriate at your bank.
Industry and Economic Outlook
This section describes the industry and economic environment in which the company competes.
Major players in the industry and the company's position in it.
What are the barriers to entering the industry?
Does the company enjoy any competitive advantages?
How does the company compete, pricing, quality, service?
If the company is diversified according to product lines, then this section would discuss the major competitive conditions according to product line. Factors impacting the industry as a whole (i.e. seasonal fluctuations, the influence of government regulations or tax and labor laws, the effect of the business cycle on the industry, etc.) should be addressed. Is the industry mature or growing? What new technologies are impacting the industry? What is the economic outlook for the industry and the economy? Does foreign competition have an impact? Major risks, if any?
This section highlights the historical sources of financing operations (i.e. internally generated funds, short-term lines of credit, term loans, and trade payables) Short-term or long term? Deferred taxes? If trade checks are performed, their results should be included here (Typically, the five largest suppliers). Is the company retaining earnings to support growth?
It also describes current financing sources, including major loan covenants, type, rate and collateral (secured or unsecured) as well as amounts owed and payment practices. What is the capitalization of the company, strong or weak?
Information disclosed by Credit Agencies may be summarized in this section:
D&B Paydex 80, H/C $50,000, 3 days beyond terms
Significant Accounting Practices
This section discusses any accounting practices that differ from industry practices.
Inventory Method: LIFO, FIFO or Weighted Average; If under LIFO, what is the LIFO reserve?
% of completion vs. completed contract?
Cash or accrual basis?
Any changes in fiscal year end (C- Corps), basis, valuation and why?
Changes in accountants and the reason for these changes?
Section II: Financial Statement Analysis
The purpose of this part of the credit analysis is to highlight and explain the significant financial changes that have taken place within a company during a particular period of time. The purpose of the analysis is to note how significant trends might impact a company's ability to met its obligations.
-See our Financial Statement section for analysis tips.
The financial statement analysis includes the following sections:
Basis of Analysis
This section describes the financial statements, projections, and other financial related documents (i.e. accounts receivable agings, appraisals, etc.), personal financial information (personal tax returns, personal financial statements), and bank statements. Quality of financial statements and who prepares the financials should also be included in this section. Any credit bureaus should be listed (not analyzed) here.
The section begins with an overall evaluation of profitability by making a comparison to a prior year (i.e., stronger, weaker, consistent with, notes major changes, and outlines the reasons for those changes (for example, sale of property, losses from a fire, etc.). Included is an analysis of statement items, a relevant trend analysis and industry comparisons (available from RMA - Risk Management Association). Cover statement items in the same order as items on the income statement.
-See our Ratio Analysis section.
Sales Revenue: What has changed, how it has changed, and why? Use sales growth rate in discussing changes in revenue, i.e. Revenues increased by 45% from $100M to $145M from FY 2009 to FY 2010.
Gross Profit Margin: What has changed, how it has changed and why (COGS up, down or same; selling price up, down or same)? GPM as a percentage of sales should be compared to prior periods. For example, GPM declined by 3.24% to 18.1% of revenue, reflecting a slight decline in the sales price of widgets in order to expand market share.
Operating Profit Margin: Note what has changed by and why, examining changes within selling, general and administration expense. Determine how fixed costs are and how changes in revenue may have impacted SGA expense. For example, Operating profit improved from $23M or 23% of sales to $30M or 26%, reflecting the following: 1) Relatively fixed SGA expense which did not increase proportionately with the increase in revenue and 2) utility saving of $XX from the installation of new highly efficient lighting fixtures.
Other Revenues: What are they, their nature (recurring or non-recurring), and why they have changed?
Net Income: What has changed, how it has changed, and why? To explain changes in net income, refer specifically to changes in income or expenses.
Balance Sheet Comments
This section begins with an evaluation of the strength of the balance sheet in terms of liquidity, capital position, and quality of assets. It notes the major changes in each area and the reasons for them (i.e. changes in operating performance or management policies, acquisition of fixed assets, etc.).
Liquidity - Usually measured by ratio analysis. The current ratio measures the relationship between current assets and current liabilities. The current ratio should be compared to prior periods and to industry data (provided by RMA). The quick (acid-test) ratio eliminates the impact of inventory and compares liquid assets to current liabilities.
Current Ratio = Current Assets/Current Liabilities
Quick Ratio = (Current Assets - Inventory)/ Current Liabilities
Asset Quality - This section evaluates changes in the quality of accounts receivable and inventory and gives and explanation of these changes. This section is particularly important for banks underwriting lines of credit, asset based lines, and factoring.
Accounts Receivable: agings, turnover, concentration, charge-offs, dilution, bad debt expense and reserves for bad debt.
Inventory: inventory mix, obsolescence, returns and allowances, warranty expense, and turnover.
Where possible, include both dollar amount and percentage changes. Days turnover should be compared to the RMA industry comparisons.
Capital Position: This section begins with an overall evaluation of the adequacy of capital and notes changes and the reasons for those changes, For example, additional capital contributed, sale of stock, retained earnings, acquisition of fixed assets. The following items are included:
Statement Items: Note changes in fixed and other non-current assets, long-term debt, and equity and also the reason for those changes.
Ratio Analysis: note changes in debt to net worth ratio and the reason for those changes.
Trend analysis: note changes and the reason for them.
Comparison to industry averages: note changes and the reasons for them.
This is the most important section of the analysis. It details the firm's ability to repay the proposed credit. It discusses the primary, secondary and possibly tertiary sources of repayment and the viability and importance of each.
Specifically to be addressed is how the company will obtain the means of repayment, when repayment can be made, and how stable are the sources of repayment. The quality of the source of repayment, use the following guidelines:
For conversion of current assets, discuss the amount and quality of the various assets. Mention whether the company has been able to clean-up a line of credit in the past and evaluate the likelihood of its ability to clean-up the line in the future.
For cash provided by operations, discuss the historical cash flows of the company, identifying major sources and uses of cash. Based on historical information and your assumptions about the future, predict whether cash from operations will be adequate.
For liquidation of collateral, give a general discussion of the book amount of the collateral, and then based on your assumptions, give an estimate of their liquidation values. -See Understanding Collateral
For recourse to guarantors, list the financial condition of the guarantors, including their outside net worth, global cash flow, stability of earnings streams.
Summary and Conclusion
This section summarizes the company's overall strengths and weaknesses, makes recommendations on the loan request, and gives significant highlights related to sales and profit, liquidity and leverage, and repayment. It should summarize key information from the prior sections.
The analyst has to assume that the reader only reads the summary and conclusion and recommendation sections.
This section has three parts:
Summary Evaluation: This part summarizes overall strengths and weaknesses.
ex. Stable earnings, Low leverage
ex. Narrow customer base, Declining sales
This part indicates the analyst's recommendation on the loan request and where appropriate any changes in how the loan should be structured. The final sentence should recommend a credit grade or risk rating.
This format was developed and used by Southeast Bank, NA., a commercial bank located in Florida.