High Risk Credit Decision-Making and Forensic Financial Analysis in a World-Class Corporation

By Rosplock, Michael F. | Business Credit, June 1997 | Go to article overview

High Risk Credit Decision-Making and Forensic Financial Analysis in a World-Class Corporation


Rosplock, Michael F., Business Credit


To cope with the credit decision-making risks in this day and age, and into the year 2000, the credit department must use updated financial analysis systems, and the analyst must have the technical knowledge to look beyond the financial statistics.

The beginning process of managing financial risk, requires analysis of the following statistical information:

A - Balance sheet

B - Income statement

C - Balance sheet and income statement (percentages)

D - Assets and liabilities (percentages)

E - Ratio analysis

F - Historical analysis

G - Cash flow analysis

H - Bankruptcy Z-score analysis

I - Assessment of footnotes

J - Projection analysis

K - Trending analysis

L - Subjective analysis

M - Subjective information:

* Years in business

* Payment habits to suppliers

* Net income trend

* Bank financing terms

* Interest rate

* Security

* Payment terms

* Net sales trend

* Gross margin trend

The analyst must have in-depth knowledge of the above financial reports and subjective information to determine the level of risk and probability of bankruptcy. The measure of true cash flow and assessment of the financial condition can only be determined by a forensic financial analysis.

The credit manager and financial analyst must also take into consideration product gross margin, business viability and payment terms, before making the credit decision. All three variables, play an important role in the decision making process. As a rule of caution, never make a credit decision solely based on gross profit margin, business viability and payment terms.

Over the years, corporate credit departments have been challenged and exposed to many types of financial risks. Some of those risks plaguing corporate credit departments include recapitalization, Chapter 11 bankruptcy, LBOs and fraud. Coping with these risks involve a higher level of technical analysis, and streamlining the operational systems to minimize risk and maximize productivity. To enhance the total quality efficiencies and world class environment, the following logic is required:

* The use of technical financial analysis systems to analyze risk and cope with the downsizing factor.

* Obtaining updated financial information on high risk corporations and establishing a network of sources (customers, bankers, factors, etc).

* Taking advantage of industry standard statistics to manage and analyze customer risk.

* Knowledge of product profit margin - essential in credit decision making.

* The use of banking information - a tremendous benefit, but the rate of success is primarily contingent upon the knowledge and ability of the analyst to extract the so-called sensitive financially proprietary information and statistics.

* Systems must be able to track national and high risk accounts, to monitor A/R exposure and financial risk.

* Communications between sales and credit must be at a higher level. Both parties must be open-minded enough to differentiate between sales benefit, financial risk and cost benefit.

* Consider the following when confronted with complex credit decision making. This logic should be used strictly on corporations with a fair to excellent financial condition:

A - If the product profit margin is high, and the financial trend is steady to improved, give order consideration.

B - If the product profit margin is high, and the financial trend is down, negotiations regarding terms and security might be required before approving the order.

C - If the product profit margin is low to medium, and the financial trend is improved, give the order consideration.

D - If the product profit margin is low and the trend is down, negotiate for the lowest payment terms and perhaps require additional security before approval is considered. …

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