FINANCIAL ANALYSIS BY BANKS AS LENDER :
The worldwide major definition of an entrepreneur is “one who takes Calculated Risk”. Since Risk term is there all the 100% borrowings may not show a success. In the beginning itself the project or person should be judged by using financial analysis to understand past trend and future projections and arrive at a safer decision (not higher in risk).
While considering a loan proposal, apart from the borrower’s integrity and KYC aspects, the banks are interested in knowing the financial details of the prospective borrower. The extent of these details depend upon the type of loan, type of borrower, purpose of the loan etc. In case of security based lending like loans against fixed deposits, etc, these financial details may be few or may not be required at all. However, in other cases of both fund based as well as non fund based limits, banks need to ensure collection of all relevant financial data, and other relevant information, to make a proper decision. Some of the important areas are:
(1) Net Worth of the borrower:
For an individual, the excess of his assets over his liabilities is his net worth. The same thing applies to any business entity as well but, to consider various types of loans and advances, banks should be careful to evaluate the net worth. This helps in understanding that the borrower is of good worth to raise funds to meet the margin component of loan and DER (Debt Equity Ratio) should be adequate (more than 2:1).
(2) Viability:
Banks should assess the viability of the business unit, most its operational capacity and its ability to increase it’s production with the proposed bank loans. This is one of the important consideration for a bank in credit assessment (working capital finance and term finance). A scrutiny of the financial records of the existing activities help bank in assessing whether the proposed bank loan will result in a significant increase in operations. The viability covers two aspects and that being technical feasibility and economic viability of the projects.
(3) Repayment Capacity:
Depending upon the type of borrower, his loan repayment capacity is determined. In case of an individual, the banks collects information like his income (salary, interest, dividend, etc.) and also his expenditure, including repayments of existing borrowings, if any, to assess the surplus available for repayment of installment and interest on bank’s loan. However, in case of a business concern, banks obtain most of the required information from its financial statements and for other information banks collect information through their due diligence process.
(4) Assessment of Performance and Financial Position:
An analysis of the financial statements reveals the trend of growth of business and its profitability. The review of the financial statements reveal the composition of assets and liabilities of the company. By comparing these to the industry trend, risk factors are identified and and opinion about the management and efficiency of the enterprise is formed. This also indicates the Risk factors in various financial management areas by the management of the company.
(5) Financial Health Indicators:
Financial statement analysis is an important tool in identifying direction of business of the company. It also assists the bank in determining the status of the financial health. The financial analysis helps the banker to detect any deterioration of its financial health and enable the bank to take preventive/ corrective measures to avoid/ minimize losses. It also provides room to the bank infusing additional loan for expansion or increase in level of operation by enhancing the loan limits.
(6) Assessment of Credit Requirements:
Despite all best efforts, one of the difficulties faced by the banks is to accurately assess the financial need of the borrower. Over-financing and under-financing both are risky for the borrower as well as for the bank. Financial statement analysis is used by banks to assess the credit requirement to overcome this issue. Banks are also concerned with repayment of loan interest within a reasonable time. Analysis of the financial statements of the borrower helps to assess the repayment schedule and also to assess credit risk and decide the terms and conditions of loan. The analysis also indicates the diversion of the fund outside the company or within the company, not in good taste
(7) Cross Verification:
The statements of stocks and book debts, as on the date of the balance sheet, submitted by the borrower, for calculation of drawing power in the cash credit account, are cross checked with the figures given in the balance sheet. In case of doubt, while assessing working capital requirements, physical stock statement of inventories held should be critically examined. Stocking of stocks can be categorized into three that are Fast moving stocks, Slow moving stocks and Non-moving stocks, termed as (FSN). Also, out of Sundry Dr the doubtful Sundry Dr. needs to be examined. This helps in proper purification of working capital requirements and saves the future prospect of survival and growth.