Question

Scenario: You are a loan officer for White Sands Bank of Sandia. Paula Jason, president of P. Jason Corporation, has just left your office. She is interested in an 8-year loan to expand the company's operations. The borrowed funds would be used to purchase new equipment. As evidence of the company's debt-worthiness, Paula provided you with "facts". 2019-10-20_1407.png Paula is a very insistent, some would even say pushy. When you told her you would need additional information before making your decision, she acted offended and said, "What more could you possibly want to know?"

Develop a minimum 700-word explanation, trying to get Paula as a bank client in the long run, of the financial statements and include the following: Explain why you would want the financial statements to be audited. Discuss the implications of the ratios provided for the lending decision you are to make. That is, does the information paint a favorable picture? Are these ratios relevant [Note: not all of them are] to the decision? State why or why not. Evaluate trends in the performance of P. Jason Corporation. Identify each performance measure as favorable or unfavorable and explain the significance of each. List three other ratios you would want to calculate for P. Jason Corporation, and in your own words explain in detail why you would use each. Based on your analysis of P. Jason Corporation, will you recommend approval for the requested loan? Provide specific details to support your decision.

Answer 1

The focus of an audit is to obtain verification from an independent source that the numbers on the financial statements are correct. Audited financial statements from a CPA provide assurance that the financial statements have been properly prepared in accordance with generally accepted accounting principles and the numbers are materially correct.

Bankers are interested in CPA-prepared financial statements because they rely on the numbers to perform an analysis to determine if you can pay them back and how much collateral is available to secure a loan. They are also interested in the details provided in the footnotes to the financial statements, as they provide a wealth of information about the business’ assets and liabilities.

To assist in assessing the viability of a commercial loan, lenders use the audited financial statements to calculate various ratios to monitor the borrower's business and its ability to repay loans. Lenders use ratio analysis as a tool to quantitatively understand and measure a business’s performance, as it is a method by which a company’s operations can be evaluated using the balance sheet, income statement, and statement of cash flows.

P. Jason Corporation is interested in a term loan, which shall be repaid in equated installments, i.e composed of an interest component and loan repayment component. Therefore, the three most important ratios for a bank in deciding whether a loan may be sanctioned or not are:

• Current ratio
• Quick ratio
• Debt Service Coverage Ratio

Current ratio = Current Assets / Current Liabilities. This is a ball park liquidity ratio aimed at establishing how comfortable the borrower is in repayment of short term debt obligations.

Quick ratio : ( Current Assets - Inventory ) / Current Liabilities. The quick ratio, also called the acid test ratio, is a liquidity ratio that measures the ability of a company to pay its current liabilities when they come due with only quick assets. Quick assets are current assets that can be converted to cash in the short-term (typically within 90 days). Cash, cash equivalents, short-term investments or marketable securities, and current accounts receivable are considered quick assets. If a company has enough quick assets to cover its total current liabilities, the company more likely will be able to pay off its obligations without having to sell any long-term or capital assets

Debt service coverage ratio (DSCR ): This is a financial leverage ratio, and is aimed at determining whether the cash flows of the company after the disbursement of the loan would be sufficient to pay off its debt obligations. It is computed as EBITDA / ( Interest + Principal ). The DSCR measures the ability of a company to use its cash operating income to repay all its debt obligations, including repayment of principal and interest on both short-term and long-term debt.