Beruflich Dokumente
Kultur Dokumente
Credit Analysis
10-2
• Your decision on IMC’s one-year loan application is positive for at least two reasons.
– First, your analysis of IMC’s short-term liquidity is reassuring. IMC’s current ratio of 4:1suggests a considerable
margin of safety in its ability to meet short-term obligations.
– Second, IMC’s current assets of $1.6 million and current ratio of 4:1 implies current liabilities of $400,000 and a
working capital excess of$1.2 million. This working capital excess totals 60 percent of the loan amount.
• The evidence supports approval of IMC’s loan application. However, if IMC’s
application is for a 10-year loan, our decision is less optimistic.
• While the current ratio and working capital suggest a good safety margin, there are
indications of inefficiency in operations.
– First, a 4:1 current ratio is in most cases too excessive and characteristic of inefficient asset use.
– Second, IMC’s current ratio is more than double that of its competitors. Our decision regarding a long-term loan
is likely positive, but substantially less optimistic than a short-term loan.
10-8
• But be careful
• Note of caution
– Quality of current assets and the composition of current liabilities are
more important in evaluating the current ratio.
– Working capital requirements vary with industry conditions and the
length of a company’s net trade cycle.
10-10
We estimate Technology Resources’ purchases per day as: • The longer the net trade cycle, the larger
Ending inventory $ 50,000 is the working capital requirement.
Cost of goods sold 320,000
370,000 • Reduction in the number of days’ sales in
Less: Beginning inventory (100,000) receivables or cost of sales in inventories
Cost of goods purchased and manufactured 270,000 lowers working capital requirements.
Less: Depreciation in cost of goods sold (30,000)
• Comparisons using industry current
Purchases $240,000
ratios, and analysis of working capital
Purchases per day = $240,000/360 = $666.67
requirements using net trade cycle
measures, are useful in analysis of the
adequacy of a company’s working capital.
10-11
• Example:
• Cost savings are assumed to derive from paying off current liabilities with money not invested in
inventory. Accordingly, cost savings equal (Inventory reduction * 10%). Under the old system,
inventory equaled $5 million.
• This is obtained using the inventory turnover ratio: 20 = $100 million / Average inventory.
• With the new system, inventory equals $4 million; computed using the new inventory turnover: 25
= $100million / Average inventory. The cost savings are $100,000, computed from ($5 million - $4
million) * 10%
10-22
Illustration
Texas Electric’s current assets along with their common-size percentages
are reproduced below for Years 1 and 2:
Cash $ 30,000 30 % $ 20,000 20 %
Accounts receivable 40,000 40 30,000 30
Inventories 30,000 30 50,000 50 %
Total current assets $100,000 100 % $100,000 100
Cash $ 70,000
Accounts receivable 150,000
Inventory 65,000
Accounts payable 130,000
Notes payable 35,000
Accrued taxes 18,000
Fixed assets 200,000
Accumulated depreciation 43,000
Capital stock 200,000
Sales $750,000
Cost of sales 520,000
Purchases 350,000
Depreciation 25,000
Net income 20,000
(continued)
10-28
Basics of Solvency
• Solvency — long-run financial viability and its ability to
cover long-term obligations
• Capital structure — financing sources and their
attributes
• Earning power — recurring ability to generate cash from
operations
• Loan covenants — protection against insolvency and
financial distress; they define default (and the legal
remedies available when it occurs) to allow the
opportunity to collect on a loan before severe distress
10-30
Basics of Solvency
Capital Structure
• Equity financing
– Risk capital of a company
– Uncertain and unspecified return
– Lack of any repayment pattern
– Contributes to a company’s stability
and solvency
• Debt financing
– Must be repaid with interest
– Specified repayment pattern
Basics of Solvency
Motivation for Debt
• From a shareholder’s perspective, debt is a
preferred external financing source:
– Interest on most debt is fixed
– Interest is a tax-deductible expense
• Financial leverage - the amount of debt
financing in a company’s capital structure.
– Companies with financial leverage are said to be
trading on the equity.
10-32
Basics of Solvency
Financial Leverage- Illustrating Tax Deductibility of Interest
10-33
Basics of Solvency
Adjustments for Capital Structure - Liabilities
Earnings Coverage
Earnings to Fixed Charges
Earnings Coverage
Earnings to Fixed Charges
10-40
Earnings Coverage
Times Interest Earned
• Times interest earned ratio
– Considers interest as the only fixed charge needing
earnings coverage:
Earnings Coverage
Earnings Coverage
Earnings Coverage
Interpreting Earnings Coverage
– Earnings coverage measures provide insight into the
ability of a company to meet its fixed charges
– High correlation between earnings-coverage
measures and default rate on debt
– Earnings variability and persistence is important
– Use earnings before discontinued operations,
extraordinary items, and cumulative effects of
accounting changes for single year analysis — but,
include them in computing the average coverage
ratio over several years
10-45
Earnings Coverage