Once upon a time, the clicking sound of typewriters

was the hallmark of any office. Nowadays, the

traditional typewriter is found in very few offices.
Industries decline and vanish, taking the participants
with them.
 CONCERNING POINTS ???
• 1. Why does profitability differ among various industries?
• 2. What are the reasons for consistency in profitability in
certain industries while others show wide fluctuations?
• 3. How do operating risks differ from one industry to
another?
• 4. What are the implications of industry risks?
• 5. What are the forces determining the level of
competition in an industry?
• 6. Will an industry that performed well in one time
period continue to do well in future?
 Continued…
• The life stage, composition, nature,
characteristics and structure of an industry
are to be studied to find answers to the points
DISCUSSED.

• Hence, industry analysis is an indispensable

part of credit risk analysis.
 TYPES OF INDUSTRY RISKS
• Before getting down to the details of industry
analysis, it is better to bifurcate (=to divide
into two separate parts ) the operating risks as
follows:
• A- Risks emanating from external
environment.
• B- Industry-specific risks.
 INDUSTRY LIFE CYCLE – (ILC)
• Just as a human being moves from birth to
adolescence to youth to middle age and to old
age, the life of an industry can be captured by
a five-stage model.
• Proper industrial classification and a sound
understanding of the stage through which the
industry is passing through are essential.
Diagram-(ILC)
 Highlights – (ILC)???
• The growth to stabilization stage can be
considered to be low/moderate risk stages,
the pioneering and decline stage are high-risk
categories.
• However, unlike human beings, certain types
of industries enjoy a life cycle spanning
centuries—shipping, insurance, banking,
railways, etc.
 PERMANENCE OF INDUSTRY
• Industrial profitability pales into insignificance if
its life is short.
• Similarly, an industry in the last stages of its life
cycle also has less permanence.
• For Example; Banking and Shipping industries
have better permanence. Why???
• In today’s world of rapid changes, especially in
technology, the permanence of an industry is of
vital importance.
 GOVERNMENT ATTITUDE AND
INDUSTRY
• The priorities of the government do affect the
industry.
• While the general attitude of the government to
overall industry (nationalization, liberalization,
etc) is important, specific industry-driven policies
are vital.
• Most governments are against the tobacco
industry and devise policies discouraging smoking
and other forms of tobacco consumption.
 FACTORS OF PRODUCTION &
INDUSTRY
• Land (natural endowments), labour, capital
and entrepreneurship are the classic concepts
of factors of production, which now stand
slightly modified to money, man, machines,
material, and management.
• Risks related to the factors of production are
very vital as they dictate competitiveness,
especially on a global scale.
BUSINESS CYCLES AND INDUSTRY
• While certain industries such as the food
industry are not at all impacted by cycles,
(Non-Cyclical industries) others;
• Like chemical industries and construction-
related industries move in tandem with
business cycles and are generally known as
cyclical industries.
 INDUSTRY PROFITABILITY
• PROFITABILITY and cash generation capacity
of a Particular INDUSTRY depends on;
– Competition among the existing firms within the
industry
– Threat of new entrants
– Threat of substitute products
– Bargaining Power of Buyers
– Bargaining Power of Suppliers
1) Competition among the existing
firms within the industry
• i Industry growth rate: The higher the growth
rate, the lower the competition
• ii Number of rivals: If the rivals are few, like in the
case of oligopoly, an implicit understanding or
rules of competition may be laid.
• iii Differentiation: If the products are
differentiated by means of branding or by other
means, the competition tends to be lower
 Continued…
• iv. Switch costs: If the switching costs are
higher, the competition tends to be lower as
the consumer would prefer the same product
to avoid higher switching costs.
• v. Level of fixed costs and overcapacity: If both
are on the higher side, the producer would aim
at higher output in an attempt to reduce fixed
cost per unit, and the resultant excess supply in
the market is sure to heat up the competition.
 Continued…
• vi Exit barriers: If the exit barriers are low,
some of the marginal players may quit the
industry without much loss to stakeholders,
especially shareholders.
 2) Threat of new entrants
• the higher the entry barriers, the better for the
existing players. The barriers are usually
determined by the following:
• i Economies of scale: Large economies of scale
act as a barrier for a new entrant
• ii first-mover advantage: Early entrants or
pioneers in the industry can dominate the
industry in such a way that a new entrant cannot
pose a direct challenge to the first mover.
 Continued…
• iii. Channels of distribution and relationships:
High cost of developing new channels can be
an effective entry barrier.
• iv. Legal Barriers: Aspects like licensing,
patents, copyrights, etc, act as effective
barriers. Long term contracts with a
Government become a barrier for new
entrants.
 3) Threat of substitute products
• If substitute products are available, then the
industry profitability is affected by the factors
influencing the substitutes. If tea and coffee
are substitutes, the suppliers of coffee cannot
increase the price beyond an extent as the
consumers will prefer tea.
 Continued…
• Ultimately, the threat from substitutes is directed
by:-
• (a) relative price
• (b) relative performance or the satisfying ability and
• (c) customers’ willingness to pay for the substitute.
• These differ from industry to industry.
• 4) Bargaining Power of Buyers
• 5) Bargaining Power of Suppliers
 COMPETITOR ANALYSIS
• In an industry that has several players, it is
better to take a look at what others are doing.
• A competitor analysis highlights the strengths
and opportunities in the 'rest of the field'.
• Competitor analysis within the industry
analysis framework is highly useful.
 INTERNAL RISKS
• Company analysis studies the third category among
business risks—internal risks or company- /firm-level
risks.
• Decision-making skills, policies and competencies
define certain crucial risks that can make or break a
business enterprise.
• The strategies, methods, technologies, the motivation
level, etc, are a few factors that are reflected in the
performance and determine the survival of an
enterprise.
 Company Analysis
• A company analysis addresses numerous
questions such as:
• What are the company’s main activities?
• What are its mission goals?
• What are its strategies?
• How well did it do in the past?
• What are its major resources?
• How is the labour-management relationship?
 Continued…
• Relationship with suppliers and customers?
• How does it price its goods?
• How do they meet competition?
• Does it enjoy or has it built up certain
advantages over competitors?
• How will the business environment changes
impact its strategies and policies?
 UNDERSTANDING THE BUSINESS
ACTIVITY
• Knowledge of the nature of business activity
has a vital role in the study of internal risks.
• All major activities in the business should be
clearly understood. Main products, installed
capacity and its utilization, major customers,
major market segments, raw materials,
suppliers, technology and location are some
of the prime areas to be covered.
Interrelated generic operating
activities
 RISK CONTEXT AND
MANAGEMENT
• Often a company’s ability to manage its risks is
evaluated on the basis of its management’s track
record, but previous experience alone is no
guarantee that a company has sufficient risk
management capability.
• Past performance is a good guide. Also,
observations on how close the company came to
achieving its goals and why it fell short of or
exceeded them provide clarity on related risks and
risk mitigants.
 Goals and objectives:
• Strategies: Strategies are aimed at attaining
objectives and goals. Stakeholders like
investors and creditors should understand the
major strategies of a business. For instance,
while certain businesses follow a low
price/high volume strategy, others might
pursue high price/low volume approach to
achieve their goals..
 RISK IDENTIFICATION STEPS
• Interviews and Questioning
• a. Audited annual financial statements for five
years
• b. Latest management accounts/interim
financial statements subsequent to the previous
audited ones
• c. Memorandum/articles of
association/partnership deed/other legal or
government related documents
 Continued…
• d. Product brochures and other descriptive
materials on the operations and
products/services
• e. Industry background
• f. Industry competitive factors
• g. Competitive advantages.
 Continued…
• Normal information gathering topics during a
meeting are: 
• Overview of major business segments
• Comparisons with competitors and industry
norms, industry prospects
• Financial polices and financial performance
goals and non-financial operating statistics
• Management’s forecasts/projections/budgets
 Continued…
• Income statement, cash flow statement, balance
sheet, accounting practices
• Operating assumptions
• Anticipated reliance on internal cash
generation/external funds
• Capital expenditure (CAPEX) plans, financing
alternatives and contingency plans
• Type of credit needed by the obligor with related
terms and conditions.
 Market Developments and Peer
Comparison
• Peer analysis is yet another powerful tool to
identify risks as well as relative strengths and
weakness of the obligor.
• SWOT ANALYSIS / TWOS ANALYSIS ???
• The information output from a SWOT analysis is
helpful in matching the firm’s resources and
capabilities to the competitive environment in
which it operates, based on which broad
strategies can also be determined.
 MANAGEMENT ANALYSIS
• Bad management is one of the biggest risks
at the entity level, which can cause a good
business to fail, despite all favourable
factors.
• Management risk refers to the defects,
inadequacies and lack of skill and experience
in the people in key positions.
 Continued…

• 1. One-man Rule
• 2. Joint Chairman/CEO/MGD Position
• At the time of the collapse of Enron, both
positions—Chairman and CEO—were handled
by the same individual. In a normal
organizational structure, while the CEO reports
to the Board, a dotted line make him
answerable to the Chairman, who also heads
the Board.
 Continued…
• LACK OF SUCCESSION PLANNING
• Succession planning entails detailed plans as to
who would assume important responsibilities
in case of abrupt exit of present incumbents
• 3. Imbalance in Top Management Team
• 4. Weak Finance Function
• 5. Lack of Skilled Managers
• 6. Disharmony in Management
 Continued…
• 7. Change in Ownership
• 8. Cultural Rigidity
• 9. Lack of Internal Controls
• Proper internal controls go a long way in
safeguarding assets and ensuring appropriate
risk-taking complying with the procedures laid
down. Non-compliance with or laxity in internal
controls is a threat, which can cause the demise
of the organization itself.
 Continued…
• 10. Low Staff Morale
• 11. Fraudulent Management
• 12. Myopic Vision (nearsightedness)
• 13. Big Projects
• CRA should be wary of big projects, which, if
they fail, could place the health of the
company in jeopardy.
• 14. Inadequate Response to Change
 OTHER INTERNAL RISKS
• Financial risks: Several forms of financial risks
exist in a company. We will discuss
them in detail further on
• Production risks: Any event that can cause
cessation of production activity or loss
of production, falls into this category.
Breakdown of key machinery, shortage of main
inputs and natural calamities (fire, earthquake,
flood, etc) are some of these risks.
 Continued…
• Corporate risks: Risks that affect the entire
company and its future directions fall
under this category. Huge losses in a
subsidiary may carry the risk of cash down-
streaming, while a hostile takeover threat may
cause the top management to divert
attention from normal operating activities.
 Continued…
• Human Resource risks: Strikes and militant
unionism are among the risks in this
category. Other risks include very high staff
turnover, poor motivation levels, which
will lead to poor productivity levels.
• Product risks: Products with chemical and similar
ingredients can sometimes be
harmful, causing injuries to the user or
environment, resulting in penalties. It can
sometimes lead to the bankruptcies.
 Continued…
• Customer risks: Reliance on a few buyers who can easily
switch to a competitor
is a significant operating risk (concentration risk). A
strong relationship with customers
and a time-tested track record can be considered as
mitigants.
• Limited geographic area: Most of the small and
medium businesses operate within
a specified area. They lack resources to identify and
exploit opportunities available in
far markets.
 Continued…
• Key man risk: Companies that cannot
function effectively without the relationships
or expertise of certain executives are
vulnerable if such executives leave abruptly. In
the case of family businesses, if such executive
is older with no clear sibling being groomed to
take over, or if the siblings lack skills, this risk
is evident.
 Continued…
• Legal risks: Sometimes certain actions or
policies or even strategies may result in
infringement and may result in penalties,
monetary or otherwise.
• Siblings rivalry: A visionary entrepreneur
may create a formidable business
entity/group, which sometimes falls into the
hands of feuding siblings/successors.
 Continued…
• Image risks: Instances and events that lead to
the loss of consumer confidence in
the products of the company, can lead to
revenue loss and drop in profitability.
 Point to Think!!!
• CRA should have a discerning eye to identify
them. Some of the other risks can be ;
• (a) Adverse information in media,
• (b) Litigation involving top management
personnel
• (c) Poor maintenance of factory/offices
• (d) Under-utilization of capacity
 Continued…
• (e) Obsolete stock
• (f) Extravagant spending
• (g) Frequent change in auditors
• (h) Auditors having other assignments in the
company, etc.