INDEX1. RED FLAGS2. RISK3. RATIO ANALYSIS4. ACCOUNTING PERIOD5. DU PONT ANAYSIS6. DEFERRED TAX7. CREDIT RATING8. IMPORTANT KEY RATIOS9. CURRENCY CONVETIBILITY10. CURRENT ACCOUNT CONVERTIBILITY11. CAPITAL ACCOUNT CONVERTIBILITY12. WORKING CAPITALTONDON COMMITTEE

RED FLAGSRed Flags analysis comprises

credit, debt etcSEBI has introduced RED FLAGSRed Flags are identified into 4

category:1. Business & Management 2. Corporate governance risk3. Accounting risk4. Financial risk

Business & management risk:• Promoters & key mngt. Their

personal track records• Aggressive growth policy• Complicated business structure• High customer concentration

Financial Risk:•Quality of CF generation/earning ratio•Difference in w.c•Large amt of cash lying idle.•Sales generation on capital employed•Change in cash sales•Intangible asset as part of total asset.

Corporate governance Risk:•Concentration of promoters holding•Quality of board & their independence•T/O of senior mngt.•Mngt. Compensation package

Risk Methodology for Mfg co. Credit analysis of an entity begins with a review of the Economy/Industry in which the

entity operates along with an assessment of the business risk factors specific to the

entity.1. Economy & Industry Risk: The economic/industry environment is assessed to determine the degree of operating

risk faced by the entity in a given business. (key ingredients of industry risk.)

Investment plans of the major players in the industry, demand-supply factors, price trends, changes in technology, international/domestic competitive factors in the industry, entry barriers, capital intensity, business cycles etc

2. Business Risk Analysis:Few parameters involved in assessing business risk:• Diversification• Size• Seasonality & cyclicality• Cost structure • Market share

3. Financial Risk Analysis:

Financial risk analysis involves evaluation of past and expected future financial performance with emphasis on assessment of adequacy of cash flows towards debt servicing.•Cash Flows•Financial Ratios•Financial flexibility•Validations of projects & sensitivity analysis

4. Management Evaluations.

Project Risk It is any factor that may potentially interfere

with successful completion of the project. It is not an problem but recognition that a

problem may occur.Types:1. Expansion2. Debottlenecking3. Backward/Forward integration4. Diversification

Leverage BuyoutsIn LBO the acquirer anticipates that loans can be

quickly repaid through the disposal of non-core assets that the target holds.

Risks involved: Carry out the sale of non core asset or value is lower then previous

anticipation. Considering the country’s regulatory, social & law and other

situations which can be unfavorable.

RISKRisk evaluation & Fundamentals

of credit risk assessment

Risk assessment broadly involves two steps:

Identification of RiskRisk Mitigation

Industry RiskTools to evaluate:

Poter’s 5 forces.Herfindahl Hirschman Index.N-Firm concentration.

Ratio AnalysisIt is an Quantitative Tool use to

interpret the Financial statement in terms of operating performance & Financial position of the firm.Operating

performance ratio•Efficiency ratio•Profitability ratio

Risk Analysis

•Liquidity ratio•Leveraged ratio

VALUATION RATIO:•P/E ratio•Earning-growth ratio•Price to book ratio•Price to sales ratio•Enterprise value (EBITDA )•Price to cash ratio

Ratio from credit point of view:•Interest coverage ratio•Debt service coverage ratio•Current ratio•Quick ratio•Debt-Equity ratio•Overall gearing ratio

DU PONT ANALYSIS

Profitability(N.P.)

Operation Efficiency

(TOTAL ASSET T/O)

Leverage(financial leverage)

It is an mathematical expression that can be used to analyze return on equity in details.

Last Fiscal year

Trailing 12 mont

hs

Leading 12 mont

hs

Accounting Period…

Deferred Tax…

Time Differenc

e

Permanen

t Difference

Important Key Ratios -Banking point of view..

Net Interest Income Net Interest margin Capital Gearing Ratio Tier 1 CAR Credit/Deposit ratio ROTA RONW Gross Advance Net NPA

Net NPA to Tangible net worthCost to Income RatioCASA ProportionYield on AdvancesCost of DepositCore SpreadGross NPA

For comparison:•Current Ratio•Debt-Equity Ratio•Asset T/O Ratio•Return on capital employed•Inventory T/O Ratio

Credit RatingC.R are independent opinion about

relative credit risk.C.R are not investment advise or buy

hold or sell recommendations. Rating Scale

Long term Short Term

Investment Grid

Non-Investment Grid

Rating Risk Weight

AAA 20%AA 30%A 50%BBB

100% BB,C,C 150%Unrated 100%

Sovereign RatingAssessment of sovereign creditworthiness i.e.

sovereign’s capacity & willingness to honor its exiting & prospective debt obligation in timely manner.

Rating is evaluated on the basis of score arrived on parameters below: Politica

l

External

finance

Macro-econom

ic

Fiscal sustainability

Currency ConvertibilityFreedom to convert domestic currency into

international expected currency & v/v.

Current account convertibilityFreedom in respect of payment & transfer for current international transfer

Capital account convertibilityFreedom of currency conversion in relation to

capital transfer in term of inflows & outflows.

CAC in IndiaFULL CAC

WORKING CAPITAL1. w.c cycle = (CA-CL)*365 / net revenue

2. Net w.c = (CA – excess cash) – CL

Methods of w.c :3. Operating cycle = debtors + stock - creditors4. Cash conv. Cycle = cash + cash +

cash inventory receivables

payables

Drawing power Drawing Power is the amount of Working Capital funds the

borrower is allowed to draw from the Working Capital limit allotted to him.

Concept of drawing power is generally applicable on CC accounts.

It is calculated by considering the total value of paid stock (Paid stock=Stock fewer Creditors) + book debts (not more

than 90 days old) & deducting margin from the same

TONDON COMMITTEEAn committee appointed by RBI for

advising to FIX MPBF for borrower.Developed in 1975Recommended 3 methods.1. Borrower’s to buy 25% of net w.c2. Borrower’s to buy 25% of c.a3. Borrower’s to buy 25% of core c.a

NAYAK COMMITTEEIn 1993, committee

recommended fixation of credit limits of small entities on the basis of projected turnover i.e. w.c limits up to 25% of projected turnover.