Credit Quality Analysis

Questions: 1. Discuss the relevance and framework of credit quality analysis for a target company? 2. Discuss the best practice financial parameters for evaluating a company credit quality and overall financial risk profile? 3. Discuss the financial credit ratios and formulae used in assessing credit quality? 4. Estimate the various financial credit ratios for Pidilite using publicly available audited financial statements? 5. Based on a trend analysis of financial credit ratios, assess Pidilite financial health and overall credit quality? Answers: Introduction In the present case study credit ratings and quality assessment has been discussed while taking Pidilite industries as a target company for the evaluation. As in particular this industry which was incorporated in late 1950s deals in two fundamental regions of operation that is ultimate consumer segment and commercial segment. This assignment relates with direction of the credit analyses survey of Pidilite industries. Credit quality analysis ratings is survey or assessment evaluating the acknowledge chance related for a specific resource. These credit portfolio for the most part require debt costs installments -, for example, debt funds and venture capital structure. How powerful administration of Pidilite industries is in controlling and checking credit hazard is discussed in below mentioned assignment. 1. Credit quality analysis of Pidilite Industries As per Hau, et. Al., (2013) a credit quality analysis is an important tool in the current scenario that has been used by many investors, lenders and other stakeholders and shareholders of the company to assess the current position and performance of the company with assessing the effectiveness of the internal controls of the company that has been put in place by the management. Through the help of credit analysis, one can test the credit worthiness of business and the organization. The credit analyst tests the company and its management of Pidilite industries discussed various parameters and determines whether the company is financially sound enough to meet out all its business obligations or not. The credit analysts assesses the confidence level of the management and the company for the current as well as for the coming business financial obligations and based on the same the credit rating has been assigned to the company. The credit history and the ability of the management is also been assessed by the analyst. In the given case, the Pidilite Industries has been recommended by the equity analysts as a long term investment opportunity. In this case, it becomes important to check the financial health of the company considering all the parameters including liquidity, efficiency, profitability etc. Through the help of the above analysis one can easily determine the ability of the company to meet out its short term and long term obligations and maintain the level of solvency. This quality analysis has been done to protect the interest of the stakeholders and the investors of the company. There have been multiple instances where the interest of the stakeholders and the investors of the company have been compromised by showing fake financial position and performance to them. In this scenario, the role of the credit rating agencies increases where they test multiple companies on same parameters and give them different ratings which they think is reasonable based on the test results. 2. Financial parameters to evaluate credit quality and risk There are various financial parameters that have been used by the financial analysts to test the credit worthiness of the companies. It includes capital structure, interest coverage ratio, debt service coverage, net worth, profitability, return on capital employed, net cash accruals to total debt ratio, current ratio etc. The analyst considers the current as well as the future risk profile of the company to determine the credit rating of the company. Capital Structure: The capital structure of the company is judged through debt to equity ratio, leverage ratio etc. These test the proportion of borrowed funds in the capital mix of the company. This shows the dependence of the company on the borrowed funds as the company will have to bear some additional cost in meeting out the funding needs. The capital structure of the company depicts the strategy adopted by the management. In case of weak businesses, a company with high gearing will impact the profitability and the ability of the company to repay the debt amount (ICRA, 2016). Interest coverage ratio - The tool of interest coverage ratio is a financial barometer that measures an organization's capacity to make debt installments along with interest portion in a convenient way. Loan providers and speculators utilize this calculation to comprehend the productivity and danger of an organization. For example financial investors need to utilize this tool just to measure that the organization can pay its due debts on time without sacrificing its routine operational costs and dividends. A debt provider, then again, utilizes this tool with a scope while distinguishing whether an organization can handle extra debt. banks as a debt lender utilize this technique to figure the hazard that will result in loaning. Return on capital employed (ROCE) - ROCE shows the profits produced by an organization over the aggregate capital utilized in the organisation. The proportion thoroughly demonstrates how effectively an organization is controlled managed by its administrators, and more often not affected by the degree of its debt in organisation. This tool of measuring profitability helps to measure long haul productivity proportion since it indicates how successfully resources are giving results while thinking about long haul debt structure. A lower ROCE mirrors the organization's negative showcase over the long haul. An inclining ROCE would suggest proficient utilization of the funds utilized in the organisation, though a declining ROCE would demonstrate wasteful utilization of the funds utilized by the firm. Regardless, the ROCE of organization must be higher than its debt and other operation cost; else it demonstrates that the organization is worsening investors esteem. 3. Financial credit ratios to assess credit quality Evaluating and critical analysis of financial performance using tools of financial ratio is utilized to assess different parts of an organization's working and money related execution, for example, its productivity, liquidity and its returns on investments. Common spaces that are calculated into a FICO score are industry hazard, govt. strategy, working efficiency, monetary hazard and administration assessment. Tools of ratio evaluation are typically analyzed and compared over organizations in similar sectors, since a satisfactory proportion in one organisation might be viewed as comparably high in different industry firm. For instance, organizations in areas, for example, dealing in consumable goods regularly have a high obligation value proportion, on the other hand a comparable proportion for an innovation organization might be viewed as comparably high. As per Oshoke Sumaina, (2015) proportion examination can give an early cautioning of an impact full change or disintegration in an organization's monetary circumstance or execution. Financial analyst participates in broad calculating of the money related information in an organization's budgetary statements, regarding defining such insights. The various ratios which will result in evaluation of credit ratings of an enterprise are as follows- Ratio Description Formulae 1 Current ratio It helps to analyze short term liquidity position of the business. Accordingly it shows the repayment capacity of the business for the short term liabilities. It helps the financial lending firm to make a decision regarding granting the needs to businesses to fulfill their working capital needs. This tool is a liquidity proportion that evaluates an organization's capacity to pay liquid and long haul commitments. Current resources like money, money counterparts, and attractive securities can without much of a stretch be changed over into trade out the short term (EXCHANGE, 2014). Current assets / Current liabilities 2 Return on capital employed ROCE is a bookkeeping proportion utilized as a part of back, valuation, and bookkeeping. It is a helpful tool for looking at the proportionate benefit of organizations in the wake of considering the measure of utilized investments (Alrafadi Md-Yusuf, 2011). Profit before interest and tax / long term debt and capital employed 3 Interest coverage ratio The ICR or interest coverage ratio is an obligation proportion and benefit proportion helps in deciding how effortlessly an organization can deliver debt cost on pending obligation. ICR might be figured by partitioning an organization's profit before debt cost and taxation amount (EBIT). It decides how effectively an organization can pay debt costs on external liability. The more declining ICR, more beneficial the organization's obligation trouble and the more prominent the 4likelihood of liquidation profit before interest tax and depreciation / Interest and other finance administrative costs 4 Debt service coverage ratio (DSCR) DSCR is the proportion of money accessible for obligation adjusting to debt interest cost, capital loan cost and rent installments. It is a prominent standard utilized as a part of the estimation of an organizations capacity to create enough money to cover its obligation installments. The more this proportion is, the less demanding it is to acquire an advance. Profit before interest tax and depreciation / interest and administrative charges 5 Profit margin ratio It helps in analyzing the profit earned over the net revenue of the organisaation. Profit is taken after deduction of taxation. Profit after tax / net revenue * 100 6 Capital gearing ratio Capital gearing proportion is how much an organization obtains resources or to which it subsidizes its progressing operations with long term and short term obligation. Capital adapting will vary amongst organizations and ventures, and will frequently change after some time. Investigating capital portfolio implies degree of proportion of finance provided by equity share holders and the finance provided by the individuals who get an interest or profit at a settled rate. Variable income bearing securities / fixed income bearing funds 4. Financial credit ratios of Pidilite industries Ratio Analysis of Pidilite 2015 2014 Balance Sheet Cash 860 1,772 Accounts receivable, net 5,861 5,224 Total current assets 16,707 16,416 Total long-term assets 16,370 12,806 Total current liabilities 9,580 8,859 Total long-term liabilities 810 857 Total shareholders' equity 22,706 19,526 Income Statement Total sales 51,329 45,345 Total operating expenses 40,734 36,117 Income (loss) before taxes 6,779 6,123 Net income (loss) 5,085 4,471 Ratio calculations Profitability Ratios Return on equity 22% 23% Return on assets 15% 15% Net profit margin 10% 10% Leverage and Liquidity Ratios Current ratio 1.74 1.85 Quick or acid test ratio 1.13 1.26 Leverage ratio 46% 50% Long-term debt ratio 0.034 0.042 Debt to equity ratio 0.036 0.044 5. Trend analysis on the basis of above ratios While observing the financial ratios of the organisaation, Pidilite industries it has been analyzed that there no big change in the profitability of the business. Net profit margin has been same as of previous year data. However company is not witnessing in decline in performance but stakeholders demand for a constant growth. Growth is a vital element for long term sustainability of an enterprise. Apart from that there has been decline showcased while observing the return on equity investments. While checking the credibility of business from the external stakeholders point of view short term liquidity position has witnessed a negative view. Short term debt holders business credibility has been declined. From 1.85:1 in the year 2014 has been declined to 1.74:1. Accordingly debt position of business shows that incline in obligation proportion more often showcase a more steady business with the capability of life span in light of the fact that an organization with lower proportion. Ever y organisation has its own standards for obligation, yet .5 is sensible proportion. In the present case structure it is lower than the standard benchmarks of 0.5 %. An obligation with less proportion of .5 is frequently thought to be less dangerous. This implies the organization has twice the same number of benefits as liabilities. From the above calculation there has been growth in debt equity ratio witnessed. An incline in debt - equity proportion demonstrates that an organization has been forceful in sourcing its investment proposal with external obligation, there might be a more prominent potential for money related trouble if profit don't surpass the cost of obtained loans. Conclusion In the above mentioned assignment financial analyst participates in broad calculating of the money related information in an organization's budgetary statements, regarding defining such insights of Pidilite industries. There are various tools that have been used by the analysts including ratio analysis, trend analysis, projections and a detailed analysis of cash flows. Various financial ratios were discussed as per the credit ratings. FICO score was taken into account which consists of various financial ratios and performance barometer practices which are adopted by the banks and other financial lending intuitions to measure the credit ratings of an organisation. References Alrafadi, K.M. and Md-Yusuf, M., 2011. Comparison between Financial Ratios Analysis and Balanced Scorecard.American Journal of Economics and Business Administration, available at - https://thescipub.com/PDF/ajebasp.2011.618.622.pdf EXCHANGE, I.S.,2014, THE INFLUENCE OF PROFITABILITY AND LIQUIDITY RATIOS ON THE GROWTH OF PROFIT OF MANUFACTURING COMPANIES Available at - https://ijecm.co.uk/wp-content/uploads/2014/12/21215.pdf Hau, H., Langfield, S. and Marques-Ibanez, D., 2013. Bank ratings: what determines their quality?.Economic Policy, 28(74) ICRA, 2016, ICRAs Credit Rating Methodology for Non-Banking Finance Companies Available at - https://icra.in/Files/Articles/NBFC%20Methodolgy.pdfOshoke, A.S. and Sumaina, J., 2015. Performance Evaluation through Ratio Analysis.Journal of Accounting and Finance Management Available at - https://www.iiardpub.org/get/JAFM/VOL%201/PERFORMANCE%20EVALUATION.pdf