Monday, 12 April 2021


April 12, 2021 0

 Let us face it, most businesses cannot survive without leverage today. In a quest for survival and expansion, companies need to resort to debt as equity alone cannot suffice the requirements. Whether it is financing a new project, meeting working capital or expanding to a new market, a company requires funding at each stage. In India the credit or debt markets are not mature as compared to global standards, hence there is excessive dependence on the traditional banking system. However, companies issuing bonds to raise finance in India is also not uncommon.

Credit default or in simple words, inability to honour the debt repayment, is one of the most dreaded risks in the financial world since time immemorial. Sovereign debt crisis in the Eurozone in 2009, the Subprime crisis in the US in 2007 have caused bloodbath in the markets in the recent past.

On the domestic front, the blaring examples of Kingfisher airlines (outstanding debt of more than Rs.7,500 crore) and Sahara (outstanding debt of Rs 11,136 crore) are fresh in everyone’s mind. The banks have really had a tough time chasing these cases and much of it is still unresolved.

Therefore, credit risk is something that needs to be analysed very minutely. Credit analysis is defined as the as the evaluation of the ability of a company to honour its financial obligations.

Credit analysis is applicable in 2 major cases:

(1) When a company issues bonds in the market

(2) When a company seeks loan from banks/ financial institution for business purpose

When loan is sought from the bank, the bank’s credit team needs to carry out the credit analysis. When the company issues bonds or debt securities, credit rating is carried out by an independent credit rating agency.

The credit analysis mainly looks at 3 particular things:

  1. Assessing the probability of default by the borrowing company
  2. Assigning a risk rating to aid decision making
  3. Assessing the amount of loss that the lender/ bond investor would suffer in the event of default.

In a nutshell, banks and credit rating agencies look at the 5Ps viz People, Purpose, Payment, Protection and Prospects to analyse the credit worthiness of the borrower. The banks and credit rating agencies employ a lot of techniques for credit analysis such as-

  • Financial statement analysis

Bank should ask for updated firm’s financial statements or additional financial information such as such as working capital, reserves, debtors, creditors, other bank loans etc, and comparative list with the previous year levels.

  • Ratio and trend analysis

Initial projection of basic financial ratios such as accounts receivables days, inventory days, accounts payable days using scenario analysis. Have major implications for the cash position of the company. One of the most important ratio to watch out for is the Debt-service ratio. The debt service coverage ratio divides this cash flow amount by the debt service (both principal and interest payments on all loans) that will be required to be met. The debt service coverage ratio should be 1.2 or higher which means that business can afford to pay its debt requirements with an extra cover for other contingencies.

  • Detailed analysis of cash flow

The asset would include a balancing Projected Cash surplus would check whether the firm will have liquidity issues or whether it generates adequate cash to address its need. The current liabilities section of the balance sheet would another balancing account entitled “additional short-term debt” indicating the projected borrowing needs for the next year.

  • Collateral Analysis

A collateral is an instrument to mitigate Credit Risk. In unfortunate events when the Cash flow cannot repay the loan, then the collateral can be sold to recover funds to repay the outstanding principal balance and other accrued items. The estimated worth of the collateral should always be valued by an acclaimed valuer and the market price must always exceed the amount of the loan. Also, the secured party should have an undisputed lien against the collateral.

  • Credit history and repayment ability analysis

The banks or credit rating agencies analyse the historical records to check whether the company has honoured its debt repayments in the past. Any history of default of negotiated terms of loan are scrutinized thoroughly. This gives the agencies an idea about the repayment ability of the company.

  • Credit Scoring system

Often credit analysis is carried out using an objective, quantitative credit scoring system. In an accounting-based credit-scoring system, the credit analyst compares various key accounting ratios of potential borrowers with industry or group norms and trends in these variables. Often the financial model is used to directly provide the inputs to the credit scoring system. However practitioners are now moving towards a model of more rigorous statistical techniques based on the financial model developed.

Making projections: The most challenging task

Projections are the most important instrument for any credit decision. However, projections can be one of the most challenging areas of credit assessment. A financial model, based on the historical data and estimates for the future years, is a handy tool for analysis. When credit analysis is carried out, detailed analysis of the borrower and the lending facility is done. The focus is on evaluating the cash flows that are expected to be generated over the future years and whether they are sufficient to cover for the interest and principal payments during the period.

The first step in this direction is understanding how to consider assumptions about against the backdrop of the risk factors. The accuracy of projections directly depends on the underlying assumptions.  The basic steps in the credit evaluation of a loan is as follows:

The bank uses its credit rating model which analyses the risk of the borrower based on financial, business, industrial and management risks. After the due completion of the technical, financial and commercial viability of the loan is checked, and after the bank is convinced of a borrower’s financial strength, the bank chooses to sanction the loan. However, in certain cases, the bank still chooses to sanction the loan even though the financial performance is weak. In these cases, the bank considers parameters like strong order pipeline, number of profit making units, support from a public sector unit etc.

Gear up for a rewarding career in finance with Credit Analysis

Credit analysis demands use of rigorous financial models based on solid understanding of financial statements and expert modeling skills. An expert in financial modeling will possess both these desired skills. Credit analysts today find opportunities in banks, credit departments of NBFCs, credit rating companies and consultancy firms. With courses like financial modelling and Post Graduate Program Investment Banking & Capital Markets by NSE AcademyIMS Proschool offers a practical curriculum for careers in Credit Analysis.

What are Credit Analysis Ratios?

April 12, 2021 0

 Credit analysis ratios are tools that assist the credit analysis process. These ratios help analysts and investors determine whether individuals or corporations are capable of fulfilling financial obligations. Credit analysis involves both qualitative and quantitative aspects. Ratios cover the quantitative part of the analysis.  Key ratios can be roughly separated into four groups: (1) Profitability; (2) Leverage; (3) Coverage; (4) Liquidity. To learn more, check out CFI’s Credit Analyst Certification program.



Profitability Ratios

As the name suggests, profitability ratios measure the ability of the company to generate profit relative to revenue, balance sheet assets, and shareholders’ equity. This is important to investors, as they can use it to help project whether stock prices are likely to appreciate. They also help lenders determine the growth rate of corporations and their ability to pay back loans.

Profitability ratios are split into margin ratios and return ratios.

Margin ratios include:

  • Gross profit margin
  • EBITDA margin
  • Operating profit margin

Return Ratios include

  • Return on assets
  • Risk-adjusted return
  • Return on equity

Higher margin and return ratios are an indication that a company has a greater ability to pay back debts.


Leverage Ratios

Leverage ratios compare the level of debt against other accounts on a balance sheet, income statement, or cash flow statement. They help credit analysts gauge the ability of a business to repay its debts.

Common leverage ratios include:

  • Debt to assets ratio
  • Asset to equity ratio
  • Debt to equity ratio
  • Debt to capital ratio

For leverage ratios, a lower leverage ratio indicates less leverage. For example, if the debt to asset ratio is 0.1, it means that debt funds 10% of the assets and equity funds the remaining 90%.  A lower leverage ratio means less asset or capital funded by debt. Banks or creditors like this, as it indicates less existing risk.


Imagine if you are lending someone $100. Would you prefer to lend to a person that already owes someone else $1000 or someone who owes $100, given both of them make the same amount of money? It is likely you would choose the person that only owes $100, as they have less existing debt and more disposable income to pay you back.


Coverage Credit Analysis Ratios

Coverage ratios measure the coverage that income, cash, or assets provide for debt or interest expenses. The higher the coverage ratio, the greater the ability of a company to meet its financial obligations.

Coverage ratios include:

  • Interest coverage ratio
  • Debt-service coverage ratio
  • Cash coverage ratio
  • Asset coverage ratio


A bank is deciding whether to lend money to Company A which has a debt-service coverage ratio of 10 or Company B that has a debt service ratio of 5. Company A is a better choice as the ratio suggests this company’s operating income can cover its total outstanding debt 10 times. This is more than Company B, which can only cover its debt 5 times.


Liquidity Ratios

Liquidity ratios indicate the ability of companies to convert assets into cash. In terms of credit analysis, the ratios show a borrower’s ability to pay off current debt. Higher liquidy ratios suggest a company is more liquid and can, therefore, more easily pay off outstanding debts.

Liquidity ratios include:

  • Current ratio
  • Quick ratio
  • Cash ratio
  • Working capital


The quick ratio is the current assets of a company, less inventory and prepaid expenses, divided by current liabilities. A person is deciding whether to invest in two companies that are very similar except that company A has a quick ratio of 10 and the other has a ratio of 5. Company A is a better choice, as a ratio of 10 suggests the company has enough liquid assets to cover upcoming liabilities 10 times over.

    Sunday, 24 November 2019

    Government Will Not Allow You To Have Multiple Bank Accounts; Every Bank Account Must Be Reported

    November 24, 2019 0

    As of now, There is no rule to cap the number of bank accounts which can be open in one bank or a combination of banks.

    But this will soon change, as Govt is bringing in a legislation to restrict the number of bank accounts which a person can open.

    Criteria For Opening Multiple Bank Accounts

    As per reports coming in, Govt. of India and Finance Ministry is bringing in a new legislation, which will restrict the number of bank accounts which can be opened.

    There will be two type categories for bank users now: Businesses such as manufacturing, processing and other business operations wherein the customer is required to make multiple payments, daily.

    These can be exempted from this rule, but still, they will be report and inform the Govt about every bank account.

    The other type of category will be professionals, salaried employees, and general entrepreneurs, who will not be allowed to open multiple bank accounts.

    As per the nw rules, Govt. will decide how many bank accounts can they open at a time.

    The Reason Behind This New Rule

    Recently, a person in Ghaziabad was found to have 87 bank accounts with Oriental Bank of Commerce and Axis Bank. Rs 380 crore was allegedly laundered via these multiple bank accounts, and this shocked the tax authorities

    This case prompted the Income Tax Department to come up with regulation and rules related with opening of bank accounts by a single person.

    It has been found that some people open multiple bank accounts in different cities, in different banks, and this will be stopped.

    Talks on on to create a big database of all bank accounts being operated by bank customers, and there will be audit as to why multiple bank accounts are actually needed.

    The official notes circulated on this issue said, “It is expected that every branch of a bank will be providing details of accounts with the tax authorities including Goods and Services Tax (GST) officials so that database of accounts opened in different parts of the country by any particular person can be verified. If there are any discrepancies, further probe can be initiated by the authorities concerned,”

    Some other rules may also come into force, such as, if a person has a current account in a bank, then he may not be allowed to open another current account, in another bank.

    An NoC or No Objection Certificate can be also asked to be produced in such instances.

    We will keep you updated, as more details come in.

    Saturday, 31 August 2019

    Case Study Questions to be introduced in Few Papers of CA Final Examination

    August 31, 2019 1

    • Currently, In Certain Papers, individual MCQ questions covering whole syllabus are asked for 30 Marks. 
    • Soon, this format is going to change.
    • Case Study based MCQ questions are going to be introduced in Law, Audit, DT and IDT.
    • This means, A 1-2 page case study will be given and students will have to understand it and answer the MCQ questions provided below.
    • For example, In Law Paper, a Long Case Study about a company going into liquidation will be given and MCQs will be framed from this situation.
    • There is no clarity from ICAI on applicability on this change, but as per information available with FinApp, It is likely to be from May 2020 exams.

    Sunday, 3 February 2019


    February 03, 2019 0


    1. Within 2 years, Tax assessment will be done electronically

    2. IT returns processing in just 24 hours

    3. Minimum 14% revenue of GST to states by Central Govt.

    4. Custom duty has abolished from 36 Capital Goods

    5. Recommendations to GST council for reducing GST rates for home buyers

    6. *Full Tax rebate upto 5 lakh annual income after all deductions.*

    7. Standard deduction has increase from 40000 to 50000

    8. Exempt on tax on second self-occupied house

    9. Ceiling Limit of TDS u/s 194A has increased from 10000 to 40000

    10. Ceiling Limit of TDS u/s 194I has increased from 180000 to 240000

    11. Capital tax Benefit u/s 54 has increased from investment in one residential house to two residential houses.

    12. Benefit u/s 80IB has increased to one more year i.e. 2020

    13. Benefit has given to unsold inventory has increased to one year to two years.

    14. State share has increased to 42%

    15. PCA restriction has abolished from 3 major banks

    16. 2 lakhs seats will increase for the reservation of 10%

    17. 60000 crores for manrega

    18. 1.7 Lakh crore to ensure food for all

    19. 22nd AIIMS has to be opened in Haryana

    20. Approval has to be given to PM Kisan Yojana

    21. Rs. 6000 per annum has to be given to every farmer having upto 2 hectare land. Applicable from Sept 2018. Amount will be transferred in 3 installments

    22. National kamdhenu ayog for cows. Rs. 750 crores for National Gokul Mission

    23. 2% interest subvention for farmers pursuing animal husbandry and also create separate department for fisheries.

    24. 2% interest subvention for farmers affected by natural calamities and additional 3% interest subvention for timely payment.

    25. Tax free Gratuity limit increase to 20 Lakhs from 10 Lakhs

    26. Bonus will be applicable for workers earning 21000 monthly

    27. The scheme, called Pradhan Mantri Shram Yogi Mandhan, will provide assured monthly pension of Rs. 3,000 with contribution of Rs. 100 per month for workers in unorganized sector after 60 years of age.

    28. Our government delivered 6 crores free LPG connections under Ujjawala scheme

    29. 2% interest relief for MSME GST registered person

    30. 26 weeks of Maternity Leaves to empower the women
    31. More than 3 Lakhs crores for defence

    32. One lakh digital villages in next 5 years.

    33. Single window for approval of India film makers