华中科技大学：《财务报表分析》（英文版）CHAPTER 11 Credit Analysis

Credit Analysis 11 CHAPTER

11 CHAPTER Credit Analysis

Liquidity and Working Capital Basics Company Liquidity refers to the ability to meet short term obligations Liquidity is the ability to convert assets into cash or to obtain cash Short term is the longer of one-year or the company operating cycle

Company Liquidity refers to the ability to meet short￾term obligations Liquidity is the ability to convert assets into cash or to obtain cash Short term is the longer of one-year or the company operating cycle Liquidity and Working Capital Basics

Liquidity and Working Capital Basics Liquidity is a matter of degree Lack of liquidity can limit Advantages of favorable discounts Profitable opportunities Management actions Coverage of current obligations

Liquidity is a matter of degree Lack of liquidity can limit • Advantages of favorable discounts • Profitable opportunities • Management actions • Coverage of current obligations Liquidity and Working Capital Basics

Liquidity and Working Capital Basics Severe illiquidity often precedes ° Lower profitability Restricted opportunities Loss of owner control Loss of capital investment Insolvency and bankruptcy

Severe illiquidity often precedes • Lower profitability • Restricted opportunities • Loss of owner control • Loss of capital investment • Insolvency and bankruptcy Liquidity and Working Capital Basics

Liquidity and Working Capital Current Assets Current assets are cash and other assets reasonably expected to be (1) realized in cash, or(2) sold or consumed, during the longer of one year or the com pany's operating cycle Current assets include: Cash -ultimate liquid asset Cash equivalents -temporary investments of excess cash Marketable securities- debt or equity securities held as s-t investments Accounts receivable- mounts due from credit sales Inventories items held for sale in the normal course of business Prepaid expenses -advance payments for services and supplies

Current assets are cash and other assets reasonably expected to be (1) realized in cash, or (2) sold or consumed, during the longer of one￾year or the company’s operating cycle Current assets include: Cash -- ultimate liquid asset Cash equivalents -- temporary investments of excess cash Marketable securities -- debt or equity securities held as s-t investments Accounts receivable -- mounts due from credit sales Inventories -- items held for sale in the normal course of business Prepaid expenses -- advance payments for services and supplies Liquidity and Working Capital Current Assets

Liquidity and Working Capital Current Assets Classification as current asset depends on: BAlane- 1. Manament's intent 2. Industry practice Analysis must assess this classification 1 Is classification as current asset appropriate? 2. If not, then adjust accounts and amounts among current and noncurrent

Classification as current asset depends on: 1. Manament’s intent 2. Industry practice Analysis must assess this classification 1. Is classification as current asset appropriate? 2. If not, then adjust accounts and amounts among current and noncurrent Liquidity and Working Capital Current Assets Balance Sheet

Liquidity and Working Capital Current liabilities Classification as current liability depends on 1.Manament's intent 2. Industry practice Analysis must assess this classification 1. Is classification as current liability appropriate? 2. If not, then adjust accounts and amounts among current and noncurrent 3. Are current liabilities reported? 4. If not, then adjust accounts for these amounts--potential examples Contingent liabilities associated with loan guarantees Future minimum rental payments under noncancelable operating leases Progress payments under contracts Current deferred tax liabilities(and assets)

Classification as current liability depends on: 1. Manament’s intent 2. Industry practice Analysis must assess this classification 1. Is classification as current liability appropriate? 2. If not, then adjust accounts and amounts among current and noncurrent 3. Are current liabilities reported? 4. If not, then adjust accounts for these amounts—potential examples: • Contingent liabilities associated with loan guarantees • Future minimum rental payments under noncancelable operating leases • Progress payments under contracts • Current deferred tax liabilities (and assets) Liquidity and Working Capital Current Liabilities

Liquidity and Working Capital Working Capital Working capital is defined as the excess of current assets over current liabilities Widely used measure of short-term liquidity Deficient when current liabilities exceed current assets In surplus when current assets exceed current liabilities Margin of safety for creditors Aliquid reserve to meet contingencies and uncertainties A constraint for technical default in many debt agreements

Working capital is ➢ defined as the excess of current assets over current liabilities ➢ Widely used measure of short-term liquidity ➢ Deficient when current liabilities exceed current assets ➢ In surplus when current assets exceed current liabilities ➢ A margin of safety for creditors ➢ A liquid reserve to meet contingencies and uncertainties ➢ A constraint for technical default in many debt agreements Liquidity and Working Capital Working Capital

Liquidity and Working Capital Working Capital Working capital more relevant when related to other key variables such as ☆ Sales ◇ Total assets Working capital is of limited value as an absolute amount

Working capital more relevant when related to other key variables such as  Sales  Total assets Working capital is of limited value as an absolute amount Liquidity and Working Capital Working Capital

Liquidity and Working Capital Current Ratio Current assets Current ratio= Current liabilities Current Ratio Reflects on Current liability coverage -assurance in covering current liabilities Buffer against losses - margin of safety for shrinkage in noncash current assets Reserve of liquid funds --margin of safety ati against uncertainties and shocks to cash flows 不e

Current Ratio Reflects on: • Current liability coverage -- assurance in covering current liabilities • Buffer against losses -- margin of safety for shrinkage in noncash current assets • Reserve of liquid funds --margin of safety against uncertainties and shocks to cash flows Liquidity and Working Capital Current Ratio Current liabilities Current assets Current ratio=