Understanding how banks analyse your business loan application (2)
By gaining an understanding of the company's past, not only do we gain a better understanding of the company, but we also discover the entrepreneurial capabilities of the client, as well as the extent to which they are flexible and willing to take advantage of market opportunities and to mitigate the risk and problems they face.
What is the company's core business?
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With this qualitative aspect, we must determine what the business is doing. It is therefore important to understand the client's business in order to define all the fields that are relevant to the analysis and assessment of possible risks. In order to acquire the required business information, it is necessary to determine the organizational structure of larger companies. In any quality analysis, the credit officer must have an in-depth understanding of the client's industry.
Product, manufacturing process, and technical equipment
The credit officer would determine whether the object of the company activity is a merchandise, products, or services. Concerning this factor, the officer must determine the maximum and ideal production capacity, as well as whether or not there is a bottleneck in this process.
In addition, it should examine the underlying assets and their obsolescence, as well as the costs associated with preserving the funds. Both the volume of inventory and the length of time the client may go without purchasing fresh inventory are crucial pieces of information.
Market for the client
The credit officer should be knowledgeable about the client's product, the competitors, and the product's strengths, shortcomings, and price. First, the client's market must be defined geographically and in terms of the clients it serves.
Here is the list of some necessary questions to make a proper determination of the market:
Who needs the products that the company produces or sells and what is their purpose?
What is the type of demand, i.e. what is their price elasticity and possible substitution with other products?
Who buys the products, who are end users, whether the products are for final consumption or for further trade?
Does the sale of products offer additional services such as transporting products to the consumer etc.?
Who are the competitors of the borrower and how much is their market share?
Is the borrower competitive based on pricing, quality, or service in comparison to other competitors?
What is the potential demand for products, is the market overshadowed, what are the distribution channels of the product?
Buyers and suppliers
Relationship with buyers
Necessary information that bank needs for the companies’ buyers are as follows:
What are the dynamics of buying, whether they are regular buyers or are ad hoc, can their plan be planned, what is the percentage of chargeability, etc.
What is the number of buyers? This information is necessary due to the diversification of the risk of collection of receivables.
Relationship with suppliers
1.Necessary information to be obtained for suppliers of the company are as follows:
2. How many suppliers does the client operate with?
3. Is the client dependent on one supplier?
4. How easily can new suppliers be found?
5. Who pays the transport costs?
Quantitative analysis
Quantitative analysis focuses primarily on the company's financial statements, such as the Balance Sheet, Income Statement, and Cash Flow Statement. The income statement and cash flow statement describe the business's historical economic status. The balance sheet is a snapshot of the current state of a company's assets and liabilities.
Analysis of Financial Statement
Assessment of liquid assets
Cash in bank accounts, cash on hand, and bank deposits constitute liquid assets. On the day of the analysis, it is crucial for the credit officer to review the client's accounts and, if he has accounts with other banks, to get extracts from all accounts (bank statement).
Evaluation of customer accounts receivable
Trade receivables are a form of working capital that must be converted to cash throughout the collection process. In a dialogue with the client, the corporate referent must disclose which claims are truly charged, consider up to five main consumers, and establish the method of collection and the terms agreed upon with the buyers.
The indicator for trade receivables collection might serve as an indicator for the average period of receivables collection:
Trade receivables X 365 / annual sales.
Evaluation of inventory
The corporate referent should examine the inventory structure and assess, through a conversation with the client, if the stock is competitive or uncompetitive.
For example, if the season for a stock has already gone, it will be sold at a discount for the next period, and its cost on the balance sheet at the time of the analysis will not be accurate.
The indicator of inventory turnover provides a strong basis for evaluating the stock and its age: Inventory x 365 / cost of goods sold.
If the client seeks for a loan for working capital, it is crucial that: For manufacturing enterprises, the loan repayment duration should coincide with the production process, from the acquisition of raw materials to the sale and return of finished goods. For commercial enterprises, the loan should be repaid by selling the merchandise and collecting the claims.
Evaluation of obligations to suppliers
The client's obligations to suppliers are a form of interest-free loan that must be repaid in the current year. It is essential to learn which customers suppliers depend on, the conditions of payment, and whether payment is governed by payment guarantees or letters of credit. This information will provide a more accurate depiction of the company's liquidity. The payment time for obligations owed to suppliers can be determined using the following indicator:
Short-term obligations to suppliers multiplied by 365 / the purchase price of items sold throughout the year.
Relationship between Balance Sheet and Income Statement
During the preparation of the balance sheet and the income statement, a check or cross check is made between them.
Example 1: If the value of the capital in a balance sheet of the company in 2021 is 100,000 cedis, the value of the capital in the balance sheet in 2022 is 120,000 cedis.
