Credit Analysis

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USAID-Funded Economic Governance II Project Credit Risk Workshop - Intermediate March 2006

Credit Analysis

Funded by:

©2006 BearingPoint, Inc.

Table of Contents
MODULE 3: CREDIT ANALYSIS OVERVIEW............................................................................................................................................... 1 LEARNING OBJECTIVES ...................................................................................................................... 1 FINANCIAL STATEMENT ANALYSIS ........................................................................................................ 2 THE INCOME STATEMENT ....................................................................................................................... 7 THE BALANCE SHEET............................................................................................................................ 10 RATIO ANALYSIS................................................................................................................................... 12 CASH FLOW ANALYSIS ......................................................................................................................... 19 THE DIRECT CASH FLOW STATEMENT: CONSTRUCTION STEPS ........................................................... 23 CASH FLOW DRIVERS...................................................................................................................... 33 EXERCISE: NAZRAT ............................................................................................................................... 34 SUMMARY ............................................................................................................................................. 35

Central Bank of Iraq

2006

Credit Analysis
Overview
This module will review the key components of fundamental analysis of a borrower’s creditworthiness. The emphasis will be on the analysis of the income statement, balance sheet, relevant ratios, and cash flow statement, and tying the three statements together. The module is not intended to be an exhaustive discussion, but to provide the examiner with a framework for reviewing the key elements of sound credit analysis, a crucial part of any credit approval process.

Learning Objectives
Upon the completion of this module, you will be able to:

♦ Discern best practice credit analysis techniques when reviewing borrower financial statements held by the bank, and

♦ Evaluate the appropriateness, quality and results of the credit analysis techniques used by the bank in its credit process.

Central Bank of Iraq

2-1

2006

Credit Risk Workshop - Intermediate

Financial Statement Analysis
There is no substitute for thorough and rigorous analysis of a borrower’s financial statements when attempting to determine a borrower’s creditworthiness. The balance sheet, income statement, cash flow statement, and financial projections all provide critical information about the borrower’s creditworthiness and capacity to repay. Analysis of revenues and profit margins, cash flow, leverage, liquidity, and capitalization is required in sufficient detail to determine strengths that the lender wants to preserve and weaknesses that may impact the borrower’s repayment capacity. If the bank fails to undertake rigorous analysis upfront, its capacity to protect itself against future repayment problems is limited and the quality of the loan portfolio will inevitably suffer. However, despite the importance of financial statement analysis in determining creditworthiness, the final credit decision is subjective because the most important factor in the decision is management of the borrower. An evaluation of management is based on both objective and subjective factors but is, in the end, subjective because there is no ratio or number that will inform the banker of management’s intention or willingness to repay a loan. Therefore, the credit officer...
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