Question

13. Assume you are a credit manager in charge of approving commercial loans to small business firms. Since the financial crisis, your boss wants to ensure that you make sound lending decisions. Identify the main aspects of the firm you will review and explain the type of information you hope to gain from reviewing each of those aspects. How would you determine whether a firm is financially healthy or not?  

Answer 1

Solution:

As a credit manager I will look for both Qualitative and quantitative information of the firm .

Quantitative Aspects: I will look for the following ratios

Interest coverage ratio : Interest coverage ratio is operating profit / Interest. Higher the ratio, more the ability of the firm to pay its interest easily. Generally, if this ratio is more than 3 then it is considered to be good.

Debt Service Coverage Ratio: This is EBITDA/( interest + Principle repayment ). This ratio is similar to interest coverage but it also consideres the Principle repayment part.

Debt to equity ratio: This is leverage ratio. Higher the ratio, more risky the company can be.

These are critical ratio, apart from that we can look for profitability ratio as well as the liquidity ratio like current ratio, quick ratio etc.

Qualitative Aspects: We can look for the growth in the industry, competitor analysis , GDP growth, impact of Technological echancement etc.