1

Introduction
(Getting the Big Picture)
 2

Vision
 To Be a World Class Commercial Bank
by the year 2025.

 Efficient, Excellence
 Customer Oriented
 Committed and qualified Employee
 3

Mission
 We are committed to realizing the needs
of stakeholders through enhanced
financial intermediation globally, and
supporting national development
priorities by deploying highly motivated,
skilled and disciplined employees as
well as state-of-the-art technology. We
strongly believe that winning the public
confidence is the basis of our success.
 4

Values
1. Corporate citizenship
 We value the importance of our role in
the national development endeavors and
step-up the commitment
 We abide by the laws of Ethiopia and
other countries in which we do business
 We care about the welfare of the society
and the environment
 5

Values… (cntd)
2. Customer satisfaction
 We strive to excel in our business and
satisfy customers
3. Quality service
 We are committed to offering quality
service to customers and aspire to be
branded as quality service providers in the
minds of our customers and the general
public.
 6

Values… (cntd)
4. Innovation
 We encourage new ideas that can improve
customers’ experience and the
performance of the bank.
5. Teamwork
 We recognize the importance of teamwork
for our success
 We respect diversity of viewpoints
 7

Values…(cntd)
6. Integrity
 We are committed to the highest ideals of
honor and integrity.
7. Employees
 We recognize our employees as valuable
organizational resources
8. Public Confidence
 We understand that the sustainability of our
business depends on our ability to maintain
and build up public confidence.
 8

Background
 In the prevailing dynamic and competitive business
environment excellence in customer service and proper
credit appraisal and management is a pillar around which the
very survival of a financial institution revolves. Besides, it is
one of the tracks the bank takes to maintain sustainable
business growth and achieve its vision.
 Hence, aligning to the credit policy and procedure, preparing
a training manual on credit process to provide credit
performers with a clear guidance on the elements involved in
evaluating the credit worthiness of an applicant and
subsequently to make prudent decision is found to be
imperative.
 The purpose of the training is thus to enable all performers to
have uniform understanding in appraising loan requests.
 9

Overall objectives
 To enhance efficiency and effectiveness of credit appraisal and
follow-up.
 To enhance adherence to an established principles on Know Your
Customer (KYC) among performers at all times.
 To maximize quality credit portfolio.
 To create, cultivate and promote professional and healthy credit
culture.
 To establish lifelong relationship between the Bank and its customers
through satisfying the actual need of the latter.
 To help realize the mission and vision of the Bank.
 To make the Bank’s credit operation as well as decision prudent.
 Meet the credit needs of customers through providing proper advice
and consultancy on the credit standards of the Bank and proper
business management and book of recording.
 10

Essential Aspects of Credit Analysis

General Concepts of credit Analysis
 Credit analysis refers to a critical assessment of the
borrower business strength, weakness,
opportunities and threats in general;
 11

Essential…(cntd)
 The depth of the credit analysis depends of on
nature of the request, type of business and the
associated credit risk.
 Evaluation of the business strength entails Making
an assessment on the record of meeting bank’s
obligation and identifying various risk, of which the
major ones are the following:
 Management risk
 Liquidity risk
 Business risk
 Leverage risk
 Collateral risk
 12

Essential…(cntd)
Origination of credit process
Before looking to credit analysis, having brief insight
about the credit origination, composition of the
required document for credit process, preliminary
interview and due diligence report are essential and
assist to have complete view credit process. In this
regard, some of the points to be given attention are
 Eligible borrower
 Required Loan Processing Documents
 Preliminary Interview
 13

Essential…(cntd)
 Business Visit
 Credit information
 Loan Approval Form (LAF)
 14

Essential…(cntd)
The analysis should incorporate the following
information
 Basic information of applicants
 Credit request
 Purpose
 Collateral
 Establishment, Management and Nature of the Business
 Key Customers and Suppliers of the Business
 Credit exposure
 Borrower’s Loan Account Performance
 Condition of Fixed Assets
 15

ANALYSIS AND
INTERPRETATION OF
FINANCIAL STATEMENTS
 16

Financial Analysis Meaning and

Importance
 Financial statement analysis is a process of
synthesis and summarization of financial statements
and operative data (presented in financial
statements) with a view to getting an insight into the
operative activities of a business concern.
 It is a technique of investigating the financial
positions and progress of the unit, by establishing
some relationship between balance sheet and
income statement.
 17

Financial Analysis Meaning and

Importance (Contd…)
 18

Financial Analysis Meaning and

Importance (Contd…)
 The methods employed for financial analysis using
these statements are dependent upon the need and
purpose of the user;
 Therefore, financial analysis involves compilation,
comparison and study of financial and operative
date and preparation, study and interpretation of
same;
 Financial statements are the index of the financial
affairs of a company. i.e.
 19

Financial Analysis Meaning and

Importance (Contd…)
 To the owners of the company, they reveal its progress as
evidenced by earnings and current financial condition;
 To the prospective investors they serve as mirror reflecting
potential investment opportunity;
 To the creditors they reflect the credit worthiness; labour
unions are able to know the fair sharing of bonus;
 The economist can judge the extent to which the current
economic environment has effecting its business activity;
 to the government the financial statements offer a basis of
taxation, control of costs, prices and profits and;
 To the management they reveal the efficiency with which
business affairs are conducted.
 20

Procedures for financial analysis

A. Re-organizing financial data;

B. Interpretation;
 Analysis and interpretation are closely inter-linked.
They are complementary to each other. Analysis
without interpretation is useless and interpretation
without analysis is impossible.
 Generally, the term analysis is used to include
synthesizing, summarizing as well interpretation,
since, analysis is always aimed at interpretation of
the relationships that are established in the course
of analysis.
 21

Procedures for financial analysis

(Contd…)
 Points to be considered by the analyst
During financial analysis, analysts should
understand the following features of financial
statements.
 Financial statements are organized summaries of detailed
information. Therefore, the document provides full information
about the business entity;
 Analysts should concentrate on essential or key amounts and
relationships to find out why the conditions revealed by the
financial statements existed.
 22

Procedures for financial analysis

(Contd…)
 Apart from the above issues, it is crucial to know the
following facts in order to understand financial
statement. The facts are: -
Accounting policies;
The underlying business and the non –
financial information.
 23

The fundamental concepts followed in

preparing financial statements
 The business entity concept;
 The going concern concept;
 The accrual concept (matching
principle);
 The consistency concept;
 The concept of prudence.
 24

Types of Financial Analysis

Who analyzes financial statements?
A. External analysis (i.e. Management); and
B. Internal analysis (Investors, creditors, regulatory
agencies & … stock market analysts and auditors).
 25

Techniques of Financial Analysis

 In the process of financial analysis various tools are
employed. The most prominent are listed as follows:
-
1. Comparative statements;
2. Common size statements;
3. Trend Analysis;
4. Ratio Analysis;
5. Fund flow and cash flow analysis.
 26

Financial Statements
 Financial statements are the end products of
accounting system;
 They are important for internal process, like for
planning, decision making and control;
 The conventional and widely used financial
statements are Balance Sheet, Income statements
and Cash Flow Statements. Each statement is
highlighted as hereunder: -
 27

Balance Sheet
 A balance sheet is the prime part of financial
statement that provides valuable information about
company’s position.
 It indicates the financial position of an accounting entity on a
specific date. It is valid only for a single day, the next day the
balance of the accounts may change. It will become obsolete;
 It contains the information about the current and fixed asset,
obligations of a business entity and the owners’ interest at a
specified point in time;
 In general, Balance Sheet provides a historical summary of
assets, liabilities and equity. It is a historical report because it
shows the cumulative effect of past transactions and events.
 28

Balance Sheet (Contd…)

Generally, from balance sheet one can understand
so many points, some of which are the following: -
 Balance Sheet shows whether the company survives;
 Balance Sheet shows how profitable the company can be in
future;
 The balance Sheet reveals that whether the business has
major obstacle in making profits etc.
The following item classification is widely used in
balance sheet.
 29

Balance Sheet (Contd…)

Asset Liability Equity

Current asset Current liabilities Capital
Investment Long – term debt Retained
Earning
Fixed (plant) Differed charges
asset
 30

Income Statement
 This report has greatest importance to the users of
financial statements. It is a performance report
recording the changes in income expenses, profit
and losses as a result of business operations during
the year between two balance sheet dates. The
income statement is valid for the whole year;
 Normally, income statement has the ensuring
features: -
 It is summary of revenue, costs and expenses;
 It measures the profit of the firm within this period;
 It is a link between two consecutive Balance Sheet; and
 The net effect is to increase or decrease the owners’ equity
account.
 31

Cash Flow Statement

 Cash flow statement in fact helps to understand better the
accounts of the company as it is presented by the
management. It shows how financial resources are employed
to generate revenue and ultimately profit;
 As general remark, cash flow statement is a statement
showing the change in the financial position of the company
within the fiscal year;
 The main objective of this statement is: -
 To summarize the financing and investment activity of the firm; and
 To disclose the financial position change during that period.

 Cash Flow Statement is a statement, which shows sources

and applications or uses of fund.
 32

Financial Analysis
 As explained in the previous parts, the aim of
producing financial statements is to provide
information to the users. The statements are
meaningless unless and otherwise correlation of the
figures in the statements is made. In doing so,
analysis make use of various instruments at the time
of financial analysis;
 Among these instruments, ratio analysis is the first
in the priority list. Trend analysis, cross section
analysis and common size statements are also most
widely used methods. Accordingly, using the
financial statement it is possible to assess the
repayment capacity of a business to meet its loan
and identify the source of repayment.
 33

Financial Analysis (Contd…)

 The analyst must also have done a ratio analysis in
order to assess the customer ability to repay
his/her/its debt;
 The Credit performer must analyze and interpret the
cash - flow and the financial ratios from the
historical financial accounts of the business;
 Ratios are the main tools of financial analysis. The
Credit performer compare each ratio from the
previous periods. The reason for any major changes
from one period to another must be ascertained
through discussion with the customer.
 34

Ratio Analysis (Contd…)

 It is well known that, normally ratios provide us with
a way to express the relationship between figures
and are useful tool of analyzing. There are two
instruments useful in deriving meaningful
information from ratios. These are: -
 Comparison against industry average (vertical analysis);

 Trend in ratio over time (horizontal analysis).

 In practice, horizontal analysis involves comparison
of ratio of the same company over time in order to
identify trends. Whereas vertical analysis is
comparing ratios of a particular company with the
industry average, average of similar companies in
the industry, etc.
 35

Ratio Analysis (Contd…)

Common Problem observed on Ratios: Ratios do
have a number of failings and the lists below are few
among many.
 Analysis tend to rely too much on figures produced, but the
figures are only as good as the information in financial
statements;
 Balance sheet is a one moment in time picture;
 Seasonal nature of some business;
 Cyclical nature of the business; and
 Accounting policy etc
 36

Ratios
 The most widely used ratios included activity ratios,
Leverage ratios or capital structure ratios, coverage
ratios, liquidity ratios and Profitability ratios. They
are highlighted below: -
Activity ratios
 The finances obtained by a firm from its owners and
creditors will be invested in assets;
 These assets are used by the firm to generate sales
and profits. The amount of sales generated and the
obtaining of the profits depend on the efficient
management of these assets by the firm. Activity
ratios indicate the efficiency with which the firm
manages and used its assets. That is why these
activity ratios are also known as ‘efficiency ratios’.
 37

Ratios (Contd…)
 They are also called ‘turnover ratios’ because they
indicate the speed with which assets are being
converted or turned over into sales. Thus the
activity or turnover ratio measures the relationship
between sales on one side and various assets on
the other. The underlying assumption here is that
there exists an appropriate balance between sales
and different assets;
 Many activity ratios can be calculated to know the
efficiency of asset utilization.
 The ratio reflects the increase or decrease in sales
levels for the business from one period to another.
Activity Ratio = Sales Current Period – Sales previous Period
Sales Previous Period
 38

Ratios (Contd…)
 The Lending Officer should note that changes in
sales levels are made up of two basic components:
price and volume. The breakdown of sales (i.e. price
and volume) will not be evident from the financial
accounts and must be ascertained through
discussion with the customer;
 The following are some of the important activity
ratios or turnover ratios: -
Total Asset Turnover ratio
 This ratio measures the overall performance and
efficiency of the business enterprise. It points out
the extent of efficiency in the use of assets by the
firm.
 39

Ratios (Contd…)
 Normally, the value of sales should be considered to
be twice that of the assets. A lower ratio than this
indicates that: -
 The assets are lying idle;

 While a higher ratio may mean that there is overtrading.

 Sometimes, intangible assets (goodwill, patents,
etc) are excluded from the total assets and the total
tangible assets-turnover ratio is calculated. For
calculating this ratio fictitious assets (P & L A/c
debit balance, deferred expenditure, etc) should be
ignored.
 40

Ratios (Contd…)
Capital Employed Turnover
 This is also known as ‘Sales-Net worth Ratio’. The
capital employed is equal to the non-current
liabilities plus the owners’ equity. This represents
the permanent capital or long term funds entrusted
to the firm for use by the owners and creditors. The
capital employed can be treated as equivalent to the
net working capital plus the non-current assets;
 This ratio examines the effectiveness in utilizing the
capital employed. It is calculated by dividing the
sales value by the capital employed.
 41

Ratios (Contd…)
Fixed Asset – Turnover Ratio
 This ratio measures the firm’s efficiency in utilizing
its fixed assets. Firms which have large investments
in fixed assets usually consider this ratio important.
It indicates the extent of capacity utilization in the
firm. The ratio is calculated by dividing the total
value of sales by the amount of fixed assets
invested. A high ratio is an indicator of overtrading
while a low ratio suggests idle capacity or excessive
investment in fixed assets.
 42

Ratios (Contd…)
Current Assets Turnover
 This ratio is calculated by dividing the net sales
value by that of the current assets. It indicates the
contribution of current assets to the sales.
 This ratio indicates the efficiency of the employment
of working capital. If supplemented with the net
worth turnover ratio, it indicates the under
capitalization of the overtrading of the concern.
Working Capital Turnover
 This ratio is calculated by dividing the net sales
value by the net working capital. There is no
standard norm for this ratio. It can only be stated
that the firm should have adequate and appropriate
working capital to justify the sales generated.
 43

Ratios (Contd…)
Stock Turnover or Inventory Turnover
 This ratio indicates the efficiency of the firm’s inventory
management. It is calculated by dividing the cost of
goods sold by the average inventory.
Stock Turnover = Cost of goods sold
Average sales
Cost of goods sold = Sales – Gross Profit or
Opening Stock + Purchases + Mfg. Costs – Closing Stock.
Average Stock = (Opening Stock + Closing Stock)/ 2.
 44

Ratios (Contd…)
Debtors Turnover
 Credit sales are not an uncommon feature. When the
firm sells goods on credit, book debts (receivables)
are created. Debtors are expected to be converted
into cash over a short period and hence are included
in current assets. To a great extent the quality of
debtors determines the liquidity position of the firm.
The quality of debtors can be judged on the basis of
debtors’ turnover and average collection period;
 Receivable turnover is calculated by dividing credit
sales by average receivables: -
Receivables turnover = Credit Sales
Average Receivables
 45

Ratios (Contd…)
Average Collection Period
 As stated earlier the average collection period ratio is
another device for indicating the quality of receivables.
This ratio shows the nature of the firm’s credit policy
also. The average collection period is calculated by
dividing days (or months) in a year by the receivables’
turnover;
Average Collection Period = Days in a year/12 months
Receivables’ Turnover
 The average collection period and the receivables’
turnover are interrelated. The receivables turnover can
be calculated by dividing days in the year by the
average collection period.
 46

Ratios (Contd…)
 The average collection period indicates the rigidity or
slowness of their collectability. The shorter the
period, the better the quality of debtors, since the
shorter collection period implies prompt payment by
debtors. The firm’s average collection period should
be compared with the firm’s credit terms and policy
to judge its credit and collection policy.
Inventory Turnover (in days) or Number of days in
Inventory: -
 It indicates how long the company carries its
inventories in warehouse on the average. It is
calculated using the following formula: -
Number of days in Inventory = Average Inventory X 360
Cost of goods sold
 47

Ratios (Contd…)
 Quick inventory turnover can indicate: -
 Higher demand for commodity;
 Seasonal movements;
 Insufficient purchase;
 Changed production methods (contract out);
 Fall in price of raw materials;
 Methods of inventory valuation used;
 Shortage or difficulty in obtaining supplies (raw material:
 Slow inventory turnover indicates one or more
of the following: -
 Difficulty in selling;
 Seasonal movement;
 Speculative buying;
 Inventory obsolescence;
 Over – buying in relation to need of the business;
 Deterioration of some inventory etc
 48

Ratios (Contd…)
 Given the above stated points interpretation of
inventory turnover both too small below the industry
average and too high above the industry average
should be cautiously observed;
 Lower inventory turnover in days (quick turnover)
could seem better in general. However, the following
can be the reasons: -
 Higher demand for the goods;
 Insufficient purchase;
 Method of stock valuation used;
 Shortage or difficulty in obtaining supplies (raw materials);
 Higher cost of goods sold due to production costs, etc
 On the other hand, high inventory turnover in days
(slow turnover) could be the result of: -
 49

Ratios (Contd…)
 Difficulty in selling;
 Speculative buying;
 Obsolescence and deterioration of some inventories;
 Production not matching to falling sales, etc
Average Collection Period (in days): -
Average Collection Period = Average AR X 360
Net Credit Sales
 The ratio shows the company’s internal collection
efficiency of its receivables provided that, sales are
evenly spread throughout the year. The speed at
which debts are collected is an important indicator
of liquidity. The result shows the number of days
receivables remain outside.
 50

Ratios (Contd…)
Credit Taken (In days)
 This ratio shows how fast or slow a company pays
its debts. It indicates the number of days a company
takes to settle its trade creditors. It is calculated
using the following formula: -
Creditors day = Average trade creditors X 360
Credit purchase
 This ratio gives company’s reliance on creditors to
fund operations, if purchase is evenly spread
throughout the year.
 Increase in number of creditors’ days may indicate:
 More reliance on creditors for financing company operation;
 Company is strong that is can dictate its own terms;
 Company is short of cash and cannot afford to pay its creditors etc
 51

Ratios (Contd…)
Profitability Ratio
 Every firm should earn adequate profits in order to
survive in the immediate present and grow over a
long period of time. In fact, the profit is what makes
the business firm run. It is described as the magic
eye that mirrors all aspects of the business
operations of the firm. Profit is also stated as the
primary and final objective of a business enterprise.
 52

Ratios (Contd…)
 The profitability of a firm can be measured and
analyzed from the point of view of management,
owners (i.e., shareholders in the case of companies)
and creditors.
 From the management point of view, profitability
ratios are calculated for measuring the efficiency of
operations. There are two types of profitability ratios
calculated for this purpose. They are:
 Profitability in relation to sales, and
 Profitability in relation to investment.
 53

Ratios (Contd…)
 The ratio is calculated by dividing gross profit by
sales value.
Gross profit margin = Gross Profit X 100% = Sales – Cost of goods sold
Sales Sales
 This ratio is usually expressed as a percentage. It
indicates the efficiency with which management
produces each unit of product or service.
 The following can cause declining Gross Profit.
 Lack of stocking;
 Incorrect stock valuation;
 Competence of management – pilfering by employees, bad
buying etc;
 Poor quality control – goods being returned;
 High cost of goods sold.
 54

Ratios (Contd…)
Net Profit Margin
 As that of Gross Profit, net profit margin is a
measure of profitability except it is computed after
deducting expenses.
 This ratio could be computed from two figures,
profit before or after tax.
Net Profit Margin = NIBT x 100
Sales
Net Profit Margin =NIAT X 100
Sales
Indicates the firm’s profitability after taking account of
all expenses and income taxes.
 55

Ratios (Contd…)
Operating Ratio
 The ratio is an index of the operating efficiency of
the firm. It explains the changes in the net profit
margin. This ratio is calculated by dividing all
operating expenses (i.e., cost of goods sold plus
administration and selling expenses) by sales.
Operating ratio = Cost of goods sold + Operating Expense
Sales
 This ratio is also expressed as a percentage.
 A higher operating ratio is always unfavourable because it
would leave only a small amount of operating income for
meeting non-operating expenses (like interest) dividends, etc.
In other to get an idea about the operating efficiency of the
firm, this ratio over a number of years should be studied.
 56

Ratios (Contd…)
Profitability in relation to investment
 Profitability of a firm can also be measured in terms
of the investment made. The term, ‘investment’, may
refer to total assets, total operation assets, capital
employed or the owners’ equity. Accordingly, many
profitability ratios in relation to investment can be
calculated. The important ratios are discussed here
under:
 57

Ratios (Contd…)
A. Return on assets
 This ratio is calculated by dividing net profit after
tax by total assets:
Return on assets (ROA) = Net Profit after tax
Total assets
 The different variants of the Return on assets may
be as under:
Return on Assets = Net Profit after tax
Total assets
Return on Assets = Net Profit after tax + interest
Total assets
Return on Assets = Net Profit after tax + interest
Tangible assets
 58

Ratios (Contd…)
B. Return on Capital Employed
 This is a similar to ROA except that in this ratio
profits are related to the capital employed. The term,
‘capital’, employed refers to the long-term funds
supplied by creditors and owners of the firm. This
ratio indicates how efficiently the management of
the firm has used the funds supplied by creditors
and owners.
 The Return on capital employed (ROCE) can be calculated by
using different concepts of profit and capital employed.
ROCE = Net Profit after Tax
Total Capital Employed
Or
ROCE = Net Profit after Tax
Total Capital Employed
 59

Ratios (Contd…)
ROCE = Net Profit after Tax
Total Capital Employed
C. Return on Shareholders’ Equity
 The shareholders of a company may comprise
equity shareholders and Preference shareholders.
Preference shareholders are the shareholders who
have a priority in receiving dividends (and in the
return of capital at the time of winding up of the
company).
 60

Ratios (Contd…)
Short – Term liquidity Ratios
 Short – term liquidity is measured or assessed by
comparing current asset against its counterpart
liability. There are two most commonly used ratios
discussed next.
1. Current Ratio
 It measures the margin of safety for paying current
debts as they fall due. It is an indicative of the short –
term solvency of the company.
current ratio (%) = Current Assets X 100
Current Liability
 Trends of current ratio are different to analyze and
probably could mislead. An increase may reflect an
increase solvency – positive.
 61

Ratios (Contd…)
2. Quick Ratio
 It shows the ability of a company to meet its current
obligations using funds from quick assets.
Quick ratio= Cash + short term inv. + Debtors X 100
Current Liability
 It gives more stringent test of short – term liquidity
Efficiency Ratio (Asset Turnover)
 These ratios measure how management is fully
utilizing the resources at its disposal: -
1. Stock turnover (in days)
Stock days on hand = Average stock X 360
COGS
 62

Ratios (Contd…)
2. Credit given (in days) or average collection period
Debtors’ days on hand=Average debtors X 360
Sales
 The ratio shows the company’s internal collection
efficiency provided that, sales are evenly spread
throughout the year.
 63

Ratios (Contd…)
Financial Leverage
 Successful use of debt enhances earnings for the
owners of the business, because the returns earned
on these funds—over and above the interest paid—
belong to the owners, and thus will increase the
return on owners’ equity. From the lender’s
viewpoint, however, when earnings do not exceed or
even fall short of the interest cost, fixed interest and
principal commitments must still be met.
 64

Ratios (Contd…)
1. Debt to Assets
The first and broadest test is the proportion of total
debt, both current and long- term, to total assets,
which is calculated as follows:
Total Debt= Total Debt
Total Asset
This ratio describes the proportion of “other
people’s money” to the total claims against the
assets of the business. The higher the ratio, the
greater the risk for the lender.
 65

Ratios (Contd…)
2. Debt to Capitalization
 A more refined version of the debt proportion
analysis involves the ratio of long- term debt to
capitalization (total invested capital/Capital
employed). The latter is again defined as the
sum of the long-term claims against the business,
both debt and owners’ equity, but doesn’t
include short-term (current) liabilities. This total
also corresponds to net assets, unless
some adjustments were made, such as
ignoring deferred taxes.
 66

Ratios (Contd…)
 The calculation appears as follows, when the current
portion of long-term debt, long-term liabilities, and
deferred taxes are included in the debt total:
Debt to capitalization= Long term Debt
Capitalization (Net Asset)
 The ratio is one of the elements that rating
companies such as Moody’s take into account when
classifying the relative safety of debt.
 67

Ratios (Contd…)
3. Debt to Equity
 A third version of the analysis of debt proportions

involves the ratio of total debt, frequently defined as the

sum of current liabilities and all types of long-term debt,
to total owners ’ equity, or shareholders’ investment;
 The debt to equity ratio is an attempt to show, in

another format, the relative proportions of all lenders’

claims to ownership claims, and it is used as a measure
of debt exposure. The measure is expressed as either a
percentage or as a proportion.
Debt to equity= Total Debt
Shareholders’ Investment
 68

Ratios (Contd…)
4. Interest Coverage
 One very frequently encountered ratio reflecting a
company’s debt service uses the relationship of net
profit (earnings) before interest and taxes (EBIT) to
the amount of the interest payments for the period.
This ratio is developed with the expectation that
annual operating earnings can be considered the
basic source of funds for debt service, and that any
significant change in this relationship might signal
difficulties. Major earnings fluctuations are one type
of risk considered.
 69

Business plan
 70

What is business plan?

 It is one of the crucial documents, through
which basic information of market, organization,
human resource, finance and etc are
communicated
 It is a written document that serves as a road
map in the entrepreneur’s journey from start-up
to project implementation. It describes all the
relevant elements involved in starting a new
business enterprise.
 71

Business plan…(cntd)
 It is an integration of functional plans such
as marketing, finance, production/
manufacturing and human resources.
 It is one of the most important and
unavoidable duties of a borrower, for it is a
prerequisite for lending money by borrowers
as it is difficult in most instances to lend
money without seeing business plan.
 72

Important benefits of a business plan

 A business plan is an operational plan to guide and
direct business operations. The plan will tell what is
going to be done, who is going to do it, when to do it.
To stay on budget & target, it is important to use
business plan for start-up and expansion period of the
business’s operation.
 It can improve a business by showing the owners:
 To make profit in the future,
 Which part of the business the owners can improve,
 What money the owner can expect to come into & go out of
the business,
 And can also show the bank how well the business can expect
to do in the future.
 73

Important benefits…(cntd)
 It increases the chance of success. It helps
owners to make mistakes on paper than in
the actual operation i.e. in the market place.
It minimizes the chance of failure.
 It helps the actors (operators) of the
business to know what to do & monitor the
activities properly.
 74

Contents/outline of a business plan

 There is no all purpose and general business
plan because each and every business has its
own unique condition and aspect.
 For instance, the start up of a new business
plan varies from that of expansion. Similarly, a
manufacturing business plan differs from that of
a service giving one. A business plan of one
manufacturing firm differs from another
manufacturing firm.
 75

Contents…(cntd.)
 Since each activity has its own unique feature, there is no fixed content for a business
plan.
 Yet, generally, the credit performers can refer to the following as a guideline to a typical
business plan.

A. Executive Summary
B. Background and Description of the Business.
C. Industry Analysis
D. Production Plan
E. Marketing Plan
 76

Contents…(cntd.)
F. Organizational and Management Plan
G. Financial Plan
H. Assessment of Risk
I. Appendix (contains backup material)
 77

Summery(What performer should note)

 Performers shall further carry out some form of
logical analysis which tells him/her where the
business is and where it is going.
 Whether there is qualified and dependable
management team and what skills are needed as
well as the way responsibility is delegated has to be
evaluated.
 Performers should check that there is a modality
laid down wherein review is made through a system
of regular consultation, which itself could form part
of the business’s in-house quality system.
 78

Summary…(cntd.)
 In today's changing business environment and
trends in customer buying patterns, the business
activity, whatsoever the sector might be, has to be
closely monitored. The business needs to be able to
react quickly and effectively when changes occur.
Hence, performers should assess the production
and marketing aspect of the business carefully.
 The location of the business itself and the market
where the products are supposed to be disposed
should be looked into.
 79

Summary…(cntd.)
 Availability of the right people with the right skills is
vital to every business. The plan has to cover broad
statements on recruitment, employment, induction,
training and a range of other related business
functions. All these issues have to be thoroughly
incorporated in the business plan and whether a
system is employed in the actual activity of the
business is duly checked.
 80

Summary…(cntd.)
 It is always necessary to question the assumptions
underlying projections, regardless whether the projections
are prepared by the owners or professional employees.
 Throughout the aforementioned topic we have identified
the steps to be followed to create a meaningful business
plan. To achieve success, information must be gathered
and managed, create and implement plans, and then
monitor and review the improvements. The task of
preparation will involve researching and collecting data
from inside and outside the business, establishing current
position in all key areas, determining the strategic direction
of the business, defining objectives to take the business
towards the vision formulated.
 81

Conclusion…(cntd)
 Last, and possibly most important, customers
(borrowers) must be prepared to take action and
monitor results. The task need not be onerous, and it
need not involve in expenditure other than time and
effort. But the results should outweigh any costs. With
competition is intensifying and customer expectations
are increasing, the business plan could make the
difference between success in the years ahead and
failure perhaps very much sooner. A performer, upon
submission of the document to the bank, has to further
play his/her crucial role to give life to the plan and a
desirable outcome both in the eyes of the bank and the
borrowers could be ripe.
 82

CASH FLOW
STATEMENT
 83

Introduction
 Loan requests are made based on the fundamental
principles of lending and the basic information,
among many others, which should be contained in
all credit applications is profit and loss accounts,
balance sheets and cash flow for the coming
periods.
 84

Introduction…(cntd)
 Lending money is a risky business and banks by
their nature are risk averse. In order to do that
borrowers are supposed to present pertinent
documents for the purpose of credit risk analysis, of
which cash flow statement is the prime one.
 85

Introduction…(cntd)
 Our Bank in principle follows cash flow-based
lending. The primary protection against loss is the
ability and willingness of the customers to repay the
borrowings. A security position should not render
credit performers complacent. Hence, business plan
and forecasted cash flow statement that justify full
repayment of the loan are the very documents
borrowers ought to present to the bank, for a vital
prerequisite in considering any request for loan
finance to a customer is to establish clearly how
much and what type of finance is needed as well as
guarantee the repayment of the loan.
 86

Introduction…(contd)
 It is vital that the performers ensure that proper
budgeting and cash flow procedures are
thoroughly undertaken by the customer prior to
the loan application.
 87

What is cash flow statement?

 The cash flow statement reports the cash generated
and used during the time interval specified in its
heading.
 A cash flow or funds flow statement is a statement
identifying the movement in funds in the business
from one period to another.
 The statement also shows how changes in balance
sheet accounts and income affect cash & cash
equivalents, and breaks the analysis down to
operating, investing, and financing activities.
 88

What is…(contd)
 The cash flow statement helps to
 Provide information on a firm's liquidity and solvency and
its ability to change cash flows in future circumstances;
 Provide additional information for evaluating changes in
assets, liabilities and equity;
 Improve the comparability of different firms' operating
performance by eliminating the effects of different
accounting methods and
 Indicate the amount, timing and probability of future cash
flows.
 89

Parts of cash flow statement

 Cash flow statement is partitioned into three
segments namely:
A. Cash flow resulting from operating activities
Operating activities include the production, sales and delivery of the
company's product as well as collecting payment from its
customers.
B. Cash flow resulting from investing activities
Examples of investing activities includes Purchase or sale of an asset
(assets can be land, building, equipment, marketable securities, etc.),
Loans made to suppliers or received from customers; Payments
related to mergers and acquisitions; and others
 90

Parts…(cntd)
C. Cash flow resulting from financing activities.
Financing activities include the inflow of cash from investors
such as banks and shareholders, as well as the outflow of
cash to shareholders as dividends as the company
generates income.
 91

Methods of preparation
Basically, there are two ways to prepare cash flow
statement namely:
 Direct method

This method preparing a cash flow statement results in a

more easily understood report. The direct method for
creating a cash flow statement reports major classes of
gross cash receipts and payments.
 Indirect method
 The indirect method uses net-income as a starting
point, makes adjustments for all transactions for non-
cash items, then adjusts from all cash-based
transactions.
 92

What is cash?
 Cash is regarded as the life blood of a business. A
business can survive for long periods even up to a
number of years without making profits but it can
not survive without cash. The sources of cash to a
business can be internal or external; and internal
sources can be operational or non-operational. The
main source of operational or trading cash is sales.
 93

What…(cntd)
 In order for the business to continue
running, it is vital that sufficient cash is
generated from sales to meet the regular
payments for stock, wages, electricity and
other expenses.
 A performer must be vigilant enough to spot
cash changes in the borrower’s business
cash cycle, which consequently helps to
assess repayment capacity, as cash flow
statement is dealt entirely with cash.
 94

Analysis of repayment capacity

 To analyze repayment capacity, the information
presented in regard to cash flow statement has to be
 pertinent,
 accurate and
 complete.
 95

Analysis…(cntd)
 Basically, a lending proposition should be
supported by cash flow projections
identifying how loan repayments will be
made. Estimating future repayment capacity
from historical accounts requires a good
fundamental knowledge of accounts and the
necessary expertise to relate those accounts
to the daily activities of the business. From
the accounts we can estimate the sources
and uses of cash within the business.
 96

Analysis…(cntd)
 Sources must be matched with uses to
ensure that timing differences do not result
in an inability to fund essential activities of
the business. The sources and uses of cash
is known as the cash cycle of the business
and it is vital to the continued success of a
business that it generates sufficient cash
from its operating sources to meet operating
uses including loan repayments.
 97

Sources of cash
 Cash sales
 Increase in borrowings or overdraft
 Usage of funds generated in previous periods
 Sale of fixed assets
 Investment by directors or others
 Decrease in stock
 Increase in creditors
 Cash purchases / creditor payments
 Loan repayments – permanent reductions to
overdrafts
 Payment of wages/salaries
 98

Uses of cash
 Cash purchases – Creditor payments
 Loan repayments – Permanent reductions to
overdrafts
 Payment of wages/salaries
 Payment of other expenses.
 Payment of taxes
 Purchase of fixed assets
 Payment of dividends to directors/ shareholders
 Increase in stock-increase in debtors-decrease in
creditors
 99

Methods of assessment
 In order to make an assessment of the
repayment capacity of a business to meet it’s
borrowings, we need to identify the source of
repayment for specific borrowings. A business
can have three main repayment sources.
 Sale proceeds of fixed assets
 Reductions in working capital.
 Cash flow from operations
 100

Summary
 Good credit management does not consider
collateral to be a substitute for creditworthiness,
rather on the existence of cash flow adequate to
repay the loan.
 Any proposed borrowing is closely related to both
amount and payback. Hence, the performer should
always assess how the additional borrowings
requested will enhance the business.
 101

Summary…(cntd)
 Assessment of repayment capacity is at best a
rough estimate of the ability of a business to meet
loan repayments in the future. Accounts provided by
customers are not always an accurate reflection of
business operations and such that a performer
needs to have a good knowledge of business and
finance in order to extract sufficient information
from the customer to make a reasonable
assessment.
 102

Summary…(cntd)
 A careful examination of the funds flow statement
will show the movement in funds from one period to
another. If the business is unable to generate
sufficient funds internally to meet all of its
requirements, it may resort to borrowings to meet
the shortfall. Borrowings however must be repaid
and this requires the business to generate sufficient
funds in subsequent periods to meet all of the
normal needs and also the repayments on the
borrowings.
 103

Summary…(cntd)
 There might be instances when there is reduced
operating cash-flow occurs. This may be as a result
of:
 Reduced turnover (market/economic conditions –
competition – customer demand);
 Increase in overheads (possibly poor cost control);
 Large financing charges (business over borrowed) and
 Working capital management problem.
 104

Summary…(cntd)
 Cash flow statement is an important instrument that
it helps to monitor progress by comparing actual
performance with projected figures. A banker’s
concern should be whether a business can
overcome any difficulties and any threats to the
adequacy of future cash generating ability.
 A decision by a banker on whether to ask for
detailed cash flow statement is dependent on the
business risk and the lenders opinion of the
ability/competence of management and also the
overall bank exposure.
 105

Summary (cntd)
 In developing a cash flow, assumptions are usually
the underlying bricks on which the forecast is made.
Hence, in this regard,
 It is always necessary for the performers to question the
assumptions underlying projections. Regardless
whether the projections are prepared by a customer or
his accountant or a consultant or other, they are still
attempting to predict the future. Assumptions will have
to be made. Hence, without properly established
assumptions, projections are valueless.
 106

Summary (contd)
It is also necessary to be conscious of any
management/owner bias. Are the projections
prepared on an optimistic or conservative
basis?
It is necessary to establish the limiting factor
or factors as failure by management to get this
aspect reasonably correct will render the
projections unreliable.
 107

Working capital determination

 108

Working ….(contd)
Definition of working capital
 Working Capital is the fund required by a unit for its
day-to-day working.
 Working capital is like blood circulation in our body.
 If there is insufficient working capital in an
organization, the activity of the firm gets affected
and in worst cases it chokes the firm and might be
the cause for the closure of the unit
Classification of working capital
 Gross working capital
 109

Working …(contd)
Classification of working capital
 Gross working capital

 Net Working Capital

Working capital requirement of a firm can be classified

into
 Permanent /Fixed/Regular

 Variable WC
 110

Working …(contd)
Determinants of Working capital Requirement
 Nature of business
 Size of business
 Manufacturing cycle
 Business fluctuation
 Production Policy
 Credit policy
 Growth and expansion activities
 Price level changes
 111

Working …(contd)
Determination of Firm’s Working Capital
Investment in current assets should be just
adequate/accurate, not more nor less, to the needs
of the business firm. Hence it should be optimal. In
order to determine the requirement, the method
used for assessment are
 Operating cycle method

 The Cost of Goods Sold Method

 Working Capital Required Per One Birr Sales Method

 112

Non-financial analysis
 113

Non-financial (ctnd)
 As financial assessment is very critical in credit
analysis, assessment of non financial issues of any
applicant is also equally essential part of analysis
and for better decision making as well.
 We can use different assessment tools for non-
financial analysis.
 Sometimes it will be hard to apply the assessment
tools because of a number of reasons. However with
available information analysis should be made on
issues like industry competition, degree of
concentration, availability substitute products, entry
and exit barriers, employment situation
 114

Non-financial (ctnd)
 The analysis generally allows us to better identify
the company’s strength and weaknesses.
 The factors or the information to be considered and
that should be analyzed to judge how any company
is doing non-financially are
 Management system
 Innovation
 Governance
 Employee Management
 Social and environmental Matters
 115

CONCLUSION
 After analyzing the financial as well non financial
aspect of the applicant, thoroughly goes through the
request, identify the unforeseeable risks, then
analyst screen out the positive and negative aspect
of each credit request.
 116

Conclusion
 Credit analysis is integral part of credit process. Quality Credit analysis has twin
general objective: on one hand the customer will be guided to proper type of
credit products which suits for the business and will adequately finance the
targeted end use and the customer will be satisfied; on other, it enables the bank
to make prudent decision, collects its money timely and satisfactorily, thereby,
enhance the quality of its credit portfolio and excel a quality credit cultures as
whole.
 This manual covered in detail the issues related with credit analysis, techniques
of appraising financial and non-financial aspect of the business in general. And
in specific term, it emphasizes on develop skill of knowing of customers, based
on the information gathered from the applicant’s, interviewing, business visit and
from the document collected from the applicant. It also gives insight on the
required credit processing document along with introducing of the standard
content that document expected to have for making comprehensive analysis. It
also indicates mechanisms of identifying unforeseen risk related to the business;
and thoroughly presents the basic evaluating technique of financial and non-
financial aspects credit analysis in order to screen out negative and aspect of
each credit request and give appropriate recommendation.
 117

Conclusion…(cntd)
 The well analyzed credit considered as half returned
loans. Even though quality and adequate of data are
collected from the business the applicant, and the
internal and external sources, if the analyst lacks
analytical capacity and knowhow, the output of
credit process could be misleading and the bank
ends up with Non-performing loans. Therefore, this
training manual is prepared to equip all performers
involve in Bank’s credit process with the basic
analytical and quality processing skill with the
highest ethical and professional standards of
conduct.