its just a 5mins presentation.

A Framework for Business Analysis and Valuation Using Financial Statements Topic 9 – Credit Analysis Processes/Methods of Credit Analysis Grant Credit? Credit Analysis Process Debt Ratings Distress Predictors Business Analyses • The better a firm’s future business prospects, the lower the risk to the creditor Credit Analysis Process (steps) Step 1: Analyse the potential borrower's financial status Step 2: Consider the purpose for extending credit Step 3: Nature of credit Step 4: Term and ability to repay Step 5: Security Step 6: Loan covenants Step 7: Pricing Credit Analysis Process (step 1) Step 1: Analyse the company's financial status - Links to previous analyses (e.g. strategy, accounting, financial analysis) Credit Analysis Process (step 2) Step 2: Consider the purpose for extending credit - The purpose of credit may effect the financing decision (e.g. – re -financing vs purchase new equipment) Credit Analysis Process (step 3) Step 3: Nature of credit - Open -end (e.g. – line of credit) vs Closed -end (e.g. – mortgage) Credit Analysis Process (step 4) Step 4: Term and ability to repay - How long? And, in the future do we expect that the borrower can pay? Credit Analysis Process (step 5) Step 5: Security Where required, is the security adequate? How much will be lent against the security? Credit Analysis Process (step 6) Step 6: Loan covenants - Essentially restrictions placed against the borrower Credit Analysis Process (steps) Step 7: Pricing - What (interest rate) to charge?           n T T T i i p s s PV 1 1 1 1 1 )(          n m m m i p p R D PV 1 1 1 1 ) ( Credit Analysis (information) Debt ratings provide important information to investors.

• The meaning of debt ratings : – Rating systems grade the relative riskiness of debt (e.g. AAA to C [S&P and Moody’s] plus speculative) – Debt ratings influence the yield that debt instruments must pay for investors to buy them . Credit Analysis (information) Credit Analysis (methods/tools) • Models for distress prediction – Several models have been developed over the years – One of the more popular and robust is the Altman’s Z -score model: • Debt of distressed companies present investment opportunities because they trade at steep discounts. Credit Analysis (methods/tools) • Simple example – X 1 = -0.2, X 2 = 0.3, X 3 = 0.15, X 4 = 2.5 and X 5 = 0.6 – Z = (1.2 x -0.2) + (1.4 x 0.3) + (3.3 x 0.15) + (0.6 x 2.5) + (1.0 x 0.6) – Z = 2.78 (conclusion – no material distress predicted) Credit Market (Suppliers) Listed Debt Markets Commercial Banks Other Financial Institutions Credit Market Trade Creditors Suppliers of Credit • Commercial banks: May have better knowledge of a firm, but are constrained in the amount of risk they can assume. • Other financial institutions: For example, savings and loans, insurance companies, and investment bankers. • Public debt markets: Requires that a firm have the size, financial strength and credibility to bypass the banking sector. • Trade creditors: Suppliers typically extend very short term financing to buyers. Credit Mix • Entities may use multiple suppliers of credit • Legal environments (e.g. – bankruptcy) can affect the type of borrowing