Credit analysis for Financial Management and Policy Mcom sem 2 Delhi University
credit analysis for Financial Management and Policy MCOM sem 2 Delhi University:- we will provide complete details of credit analysis for Financial Management and Policy MCOM sem 2 Delhi University in this article.
credit analysis for Financial Management and Policy Mcom sem 2 Delhi University
Credit analysis is the method by which one calculates the creditworthiness of a business or organization. In other words, It is the evaluation of the ability of a company to honor its financial obligations. The audited financial statements of a large company might be analyzed when it issues or has issued bonds. Or, a bank may analyze the financial statements of a small business before making or renewing a commercial loan. The term refers to either case, whether the business is large or small.
The objective of credit analysis is to look at both the borrower and the lending facility being proposed and to assign a risk rating. The risk rating is derived by estimating the probability of default by the borrower at a given confidence level over the life of the facility, and by estimating the amount of loss that the lender would suffer in the event of default.
Credit analysis involves a wide variety of financial analysis techniques, including ratio and trend analysis as well as the creation of projections and a detailed analysis of cash flows. Credit analysis also includes an examination of collateral and other sources of repayment as well as credit history and management ability. Analysts attempt to predict the probability that a borrower will default on its debts, and also the severity of losses in the event of default. Credit spreads—the difference in interest rates between theoretically “risk-free” investments such as U.S. treasuries or LIBOR and investments that carry some risk of default—reflect credit analysis by financial market participants.
Before approving a commercial loan, a bank will look at all of these factors with the primary emphasis being the cash flow of the borrower. A typical measurement of repayment ability is the debt service coverage ratio. A credit analyst at a bank will measure the cash generated by a business (before interest expense and excluding depreciation and any other non-cash or extraordinary expenses). 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. Commercial bankers like to see debt service coverage of at least 120 percent. In other words, the debt service coverage ratio should be 1.2 or higher to show that an extra cushion exists and that the business can afford its debt requirements.
credit analysis for Financial Management and Policy Mcom sem 2 Delhi University:-What is a credit management policy?
This is an operational document defining a number of operating rules for the sales process that must be followed by the entire company including of course the credit team.
It defines the standard conditions of sale (standard payment terms, early payment discount rate… etc.) and the processes to apply the rules (how to open an account, how to set a credit limit, how to recover the bills …etc.).
These rules are intended to do “good” sales and to converge business strategy, commercial stakes and financial issues (credit risk, cash, profitability, working capital improvement).
credit analysis for Financial Management and Policy Mcom sem 2 Delhi University:-Why implement a credit management policy?
The establishment of a procedure for credit management is necessary and critical in business since the number of employees exceeds ten and unwritten rules that are no longer appropriate. It defines the rules of operation at each stage of the sales process and clarifies the responsibilities in line with the business strategy.
Thus, it limits the internal conflicts that inevitably appear when the personal interests of the people involved differ. For example, it is common that the commercial, focused by the sale, cares little for the solvency of its potential buyer. However, an accountant or financial manager care more of the cash position and the risk to grant a credit to an insolvent client.
The policy of credit management clarifies the objectives of the company and set best practices that must be followed by the entire organization.
|Key factor of success, it must be shared between vendors, business management and finance department. It is a document which specifies operating “standard” modes for all stakeholders while providing rules for exceptions.|
Indeed, the principle of the trade is to be specific to a business relationship to another, from an economic context to another. Each company must be able to adapt its offer to it and sometimes depart from the rules of running operations it has set itself.
The division of tasks between employees can generate antagonists interests, as may be the case between finance and sales department. But the supreme interest of the company must prevail. This is the role of the procedure for credit management. It reconciles interests by setting limits to each of them and providing for arbitration in specific cases.
Operating rules established by the procedure may in some cases be overridden but within a framework defined in advance. Thus, it includes a chart of authority which determines for each decision committing an additional risk to the company the power of validation of each actor. For example, sending a new order for a customer who is in default of payment for more than 30 days may be subject to the validation of the CFO.
credit analysis for Financial Management and Policy Mcom sem 2 Delhi University:-Which the rules for which processes?
The purpose of the credit management policy is to define rules on all steps that are likely to generate business risk by committing financial resources. This is done in order to manage this risk and to minimize them.
Well managed, a risk can become an opportunity. For example, if you have evaluated a customer as insolvent, you can request a payment in advance against an interesting discount. This helps to improve cash flow of the business while avoiding any credit risk.
credit analysis for Financial Management and Policy Mcom sem 2 Delhi University:-Main stages of the sales process
Timing diagram of the sales process:
1) commercial prospection
Business development incurs costs and should be well oriented to be effective. It is for example against-productive to spend time and money to win an order with an insolvent potential client:
- The financial position of the buyer intends more to regression or disappearance through a bankruptcy rather than becoming a key player in the market,
- Win a business with this company will result in payment delays or even unpaid invoices and losses,
It is therefore essential to take into account the financial situation of companies before prospecting them. Better canvass companies in good financial health and with good potential.
These deals can be engaging for the seller, it is necessary to include commercial conditions (conditions and mean of payment, guarantees… etc) coherent with the context and the creditworthiness of the buyer. Credit risk starts at this stage. It is therefore necessary to define how it is assessed (financial analysis, credit rating etc …) and how it is managed.
3) Customer account opening
The customer opening account must follow certain basic rules to obtain necessary information in order the administrative flows are fluid and do not disrupt the business relationship. Defined rules specify what documents / information to be obtained prior to account opening and who must obtain them.
4) Payment terms and credit limit set up
This stage occurs during the trade negotiations and may be before or after the opening of account. It is here that are approved payment terms (payments, deferred payment, method of payment, invoicing schedule … etc), and any guarantees (bank guarantees, parent company guarantees, delegation of payment, documentary credit … etc.. ).
This is the heart of the prevention of outstanding risk. These conditions should be an integral part of commercial negotiations and result from risk analysis that was done previously. The credit management process defines the standard conditions, checks if it is possible to grant them to the client and manage any deviations from this rules.
5) Delivery and invoicing
This step should not be overlooked as it is often a source of disputes that generate late payment and have negative impacts on the business relationship. The credit management process specifies the prerequisites for billing in a timely manner and the key steps to check to do a good billing and not make errors (price, date of invoice, customer name, etc …).
6) Friendly collection
Essential phase not to suffer late payments, the cash collection should be structured and professionalized to be effective. Well done, debt collection lends credibility to the seller, significantly improves cash flow and contributes positively to build a commercial relationship.
The recovery process must be defined in a combined result of recovery actions (phone calls, email, mail return receipt, intervention of the sales representative … etc) and agreed between the recovery service or accounting and sales managers.
It also specifies how are used late payment penalties to get customers to pay in a timely manner.
In case of failure of amicable collection that ended with sending a letter of formal notice, collection action continues but with other means. These are numerous and depend on the organization of each company and its customer types:
- Lawsuits handled by the seller with the contribution of a lawyer (referred provision, payment order or assignment payment),
- Collection agencies,
- Credit insurers.
credit analysis for Financial Management and Policy MCOM sem 2 Delhi University
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