By Adeel Ahmed
Credit & Marketing Officer,
Askari Leasing Limited

 Apr 04 - 10, 2005



A common perception about banking profession exist that majority of the loan/credit decision made by the bankers are defective. This results in a general lack of confidence in our banking system. Yes, these have been some instances, where the loan did not perform as expected. The question arises who is culpable? Why do loans go wrong? It has been my observation that a loan may become non-performing due to any of the reasons such as change in business and political environment, misuse of working capital, mismanagement of resources by the management and disapprovals and/or decision based on incorrect information or faulty conclusion drawn from the decision.

While performing the credit decision the most important factor may be veracity of the information provided to the bankers and, secondly the communication of the information to the appropriate levels of decision makers. A lot of the times, the decision to provide funding is done for reason other than that could be supported by financial or operational logic. In such cases, the appropriate level of analysis are either by-passed or ignored so that decision may be made as desired by some quarters of management. A sound decision-making depends that all the factors that may impinge on the decision are given due consideration. Some of more important factors are financial health of borrowing company and its ability to repay, background and track record of sponsors, and also the actual required need and the amount of loan required. It often happens that an inappropriate amount either in excess or in shortage leads to financial difficulty for the company.

What all this really means that financial analyst who is preparing the proposal should be free from undue pressure from either quarters, i.e., senior management or the sponsors. He should be able to apply his independent and objective reasoning in order to reach a decision. The analyst must ensure both qualitative and quantitative factors supported the credit decision before decision supporting it, before it can be recommended to senior management. The quantitative factor will include financial health of the company, where as qualitative factors will include both operating health as well as environmental in which business exists.

Credit decisions are very important aspect of the banking life. Credit Decision..! A small word but it may have profound and intense effect on the books of any financial institutions. Once the decision has taken, it complicated or rather impossible to reverse it. To take a right credit decision is very important, but the most important is, what makes one to take the definite credit decision? The facts, figures, knowledge, experiences, information etc. There are numerous factors which contribute towards credit decision-making processes are all important. The need for sufficient and relevant information and documentation is the foundation of a credit decision. Not having sufficient information and documentations with the credit proposal can lead to chaos and rejection. Whereas copious information and documentation results in confusion and delays. There is a strong need to ensure the balance between both of them.

Credit decision related to corporate clients needs sound knowledge of corporate credit and risk analysis along with acquaintance with financial techniques to suss out the credibility of corporate clients. A credit decision maker must be aware of financial analysis and operating analysis together with some of the financial shenanigans, which some companies may resort to affect the credit decision. Few of these factors and focusing areas that contribute towards operating analysis and financial analysis in conjunction with the general financial shenanigans are as follows:


Operating analysis covers all the factors other than financial statement. These factors, however, are very important for corporate credit assessment as these factors provides the true picture of corporate clients. The first factor that contributes towards the operating analysis is sponsors and or management factors such as background, experience, net worth, related companies, depth, balance, succession, controls on management accounts, manufacturing plans and marketing/selling programmes

Other than above factors Company Market and industry factors have also an utmost importance. These factors help us to develop SWOT (strength, weakness, opportunities and threats) and PEST (political, economical, social and technological) analysis for corporate clients. Some of these factors includes, legal status i.e., sole proprietorship, partnership, or limited liability, years of establishment, paid-up capital (for limited liability), production base, owned or rented premises, technology, cost structure relative to competitors, labour/staff, supply and cost of labour/staff, product(s) and its variety, quality, price, seasonal factors, marketability, conventional or activist, prevailing and future demands of products, potential product risks, plans to minimise the risks and company position in term of its size, market share and profitability relative to competitors.



Industry factors and environmental factors, however, includes details about potential and existing competitors, barriers to entry in the related fields, growth of the market/industry, future expectations, i.e., maturing or declining and government rules and regulation concerning the particular industry, economical conditions, political and social conditions, legal and customs policy.

Besides the above-mentioned factors, which contributes a lot towards the operating analysis for corporate credit assessment, some other factors like banking relationship and reason of financing have a greatest importance in operating analysis. The credit analyst must ensure the consideration of theses factors before granting/recommending any finance facility to corporate clients. Some core areas in these factors are years of relationship with granting financial institution, types of facilities granted, payment records (any default occasions or late payments), CIB report and outstanding credit exposure. Further to this, some facility structure risks are also there such as, source of relation (in case of new client), reasons for changing/seeking additional banker/financial institution, reason for requesting finance facility and where/how the proceeds are to be applied, matching of loan amount with business needs, appropriateness of loan type (e.g. tenor matches with trading/fund flow cycle).

In case of additional collateral the security risks also arises. Some questions which must be answered before credit decision-making are marketability of furnished security and its expected forced sale value, enforcement of law, which is some times difficult due to haqshufa in some cases of mortgage on agriculture lands. In case of guarantors, his/her background, financial strength and net worth estimate and also other sources of repayment in case of default.


The financial analysis starts with sales and profitability. This is the core factor effecting the credit assessment for corporate clients. The main focusing areas under this head should be a gross profit margin, net profit margin, return on equity, growth rates of sales and net profits, sources of sales, orders on hand and comparison with industry standard (if available).

Second to the above are cash flows. The main areas of focusing under this head would be cash flows from operations, working capital movements, net operating flow and other flows. Further to this one must look for working capital management, sources/applications of operating funds, consistency between fund flows and other item of the financial statements (e.g. interest expenses decreased whereas borrowing increased) and cash flow projection and assumptions made.

Liquidity also plays vital role in corporate credit assessment. Composition of and changes in current assets/liabilities, quality of current assets, in particular, account receivable and inventories, matching of current assets and current liabilities and servicing ability are some factors that must be considered in credit decision process.

Capital structure is another important part of financial analysis. This includes composition of and changes in capital structure, quality of fixed assets (e.g. premises, plants, stocks), debtors and liabilities, matching of fixed assets/investments and long-term liabilities, interest rate exposure (both fixed and floating), contingent/off-balance sheet liabilities and ability to re-finance/raise additional finance.

All theses financial analysis are based on the financial statements and financial ratio analysis. Though they provide us the true picture of the company performance but at the same time balance sheet and financial ratios have some limitations. A credit analyst must be aware of these limitations. Some limitations are that balance sheet does not indicate the current value or market value of a company's assets, liabilities and/or owners equity. Another limitation of balance sheet is that it represents only one moment in time. Seasonal factors and unusual circumstances must be considered.

As far as financial ratios are concerned, ratios consider only information that is quantified on the financial statements. Excluded yet often equally important, are qualitative and quantitative information that is not shown on the financial statements. Therefore a good corporate credit assessment must include quantitative and qualitative factors that have been covered under the head of operating analysis.

Generally, the corporate decisions are very much based on financial statements. Though most of the time theses reports provide the true picture of the corporate entity, however sometimes by using accounting gimmick, a financial statement can easily be misreported. The financial shenanigans are the actions or omissions intended to hide or distort the real financial performance or financial conditions of an entity. They range from minor deceptions to more serious misapplications of accounting principles. Theses financial gimmicks can occur in companies of any size, public or private, new or old. By knowing what are they and how to find them, a credit analyst will be able to evaluate the performance and value of any company far more accurately. An example of financial shenanigans could be aggressive or inappropriate inventory valuation. The selection of an inventory valuation method, which can substantially affect a company's reported profits. The most popular methods chosen are last in first out (LIFO) and first in first out (FIFO). During inflationary periods, when inventory cost is rising, the differences between LIFO and FIFO could affect profits substantially.

Under these circumstances LIFO generally produces lower reported profits for a company than does FIFO, resulting also in lower taxes and therefore in higher cash flows. FIFO undervalues the rising cost of inventory and result in a higher level of reported profits. Similarly, a huge inventory in under the head of current assets may resulted a good current asset ratio, but it might be possible that majority of the inventory may even be dead inventory.

There are many other examples of financial shenanigans, through which management of any company can easily manipulate their figures to misguide the investors/analyst. Its difficult to give complete explanation of each type of financial shenanigans, however, few other examples are recording revenue before it earned, recording of bogus revenues, recording of incorrect gain or boosting income through huge gains, shifting current expenses to later period, changes in accounting principals like deprecation methods and many more. Though it is hard to find out theses financial shenanigans in audited accounts, however, one must go through the note of accounts, to get insight information related to the financial statements. These notes are actually more important than what is shown on the financial statements.

Although with no level of certainty, it can be said that loan can never will go wrong or become non-performing. Predicting future with hundred percent certainties is outside the realm of human capability. Future is uncertain and factors, which today may seem totally insignificant, may be most important one in days to come. However, the approaches/factors mentioned above can help minimize the occurrence of bad loans for a financial institution. Bad loans can have an extremely negative effect on the health of the economy and prudent banker/analyst should utilize all of his information/faculties to avoid non-performing loan.