Quantitative Risk Analysis

The Purpose

Business Characteristics

  1. The business is sufficiently liquid that it can easily meet short-term obligations.
  2. Business runs efficiently.
  3. The business is profitable.
  4. The owner's stake in the business is high; or, the business doesn't carry too much debt.

Factor for Future Repayment

The Insurance to Prevent Risk

  • Trend (time series) analysis, which is to examine a company against past data or trends, such as ratios calculated in the past.
  • A safety buffer that helps businesses even in the event of default as they store surplus income
  • Stress testing, where lenders will conduct sensitivity tests on borrowers
  • Industry analysis to see if other industries are doing well, which can help lenders see if a borrower's business will also grow
  • Economic analysis, which is more about domestic and international trade

i. Collateral
ii. Charge on assets
iii. Guarantee
iv. Conditions

Analysis of Financial Statement

Cross-Sectional Techniques

Financial Ratio

Common Size Statement

Liquidity Ratios

  • Current Ratio
  • Quick Ratio

Efficiency Ratios

  • Inventory Turnover Ratio
  • Average Collection Period

Profitability Ratios

  • Gross Profit-Sales Ratio
  • Net Profit-Sales Ratio

Leverage Ratios

  • Debt-Equity Ratio
  • Interest Coverage Ratio
  • (Fixed Charge Coverage Ratio)
  1. Intercompany comparisons are required, companies of different sizes make it difficult to compare them unless their financial statements are presented in a common form.
  2. The common form is created by expressing the components of the balance sheet and income statement as a percentage of total assets and total income.

Time Series Techniques

Time series analysis involves analyzing financial information, such as ratios over time.


  • Trend (Index Statement)
  • Trends in Financial Ratio
    Variability Measure

Variability Measures


(Maximum Value - Minimum Value)/ Mean Financial Ratio

Combining Financial Statement and Non-Financial Statement Information

  • Change in Market Value
  • Market Perceptions via Share Price
  • Change in Key Management
  • Impact of Macroeconomic Changes

10 Financial Ratios Importance in Loan Assessment by Loan Officers

Professor Altman's Formula

Altman Z-Score = [1.2 x (working capital / total assets)] + [1.4 x (retained earnings / total assets)] + [3.3 x (earnings before interest and tax / total assets)] +[ 0.6 x (market value of equity / total liabilities)] + [1.0 x (sales / total assets)].

  1. Debts-Equity Ratio
  2. Current Ratio
  3. Cashflow to Long-Term Liabilities
  4. Fixed Charge Coverage Ratio
  5. Net Profit after Tax
  6. Net Interest Earned
  7. Net Profit before Tax
  8. Financial Leverage
  9. Inventory Turnover in Days
  10. Account Receivables Turnover in Days

Advantages

Limitation

  • Ability to Detect Patterns
  • Financial Statements showing the Company's Annual Sales.
  • Sales can Fluctuate, but Financial Planners should be able to identify patterns in Years of Sales Data.
  • Will have Collateral if there's a Defaulted Loan
  • Financial Statements for Future Planning and Decision-Making is that they show a Company's Budget.
  • the Lender cannot Predict Future Repayment
  • the Lender cannot Predict the Business still can run Efficiently in the Future.