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Financial Statement Analysis

Financial statement analysis is the evaluation of a firm's financial statements in order to assess the firm's worth and its ability to meet its financial obligations. WebEquity provides the application of financial statement analysis and analytical tools to "general purpose" financial statements and related data for making business decisions based upon the financial statement information collected in WebEquity. Below are some key financial statement analysis criteria most all lenders can use and modify for use in their own underwriting.

Repayment Analysis

In financial statement analysis, the repayment analysis criteria can provide a useful means for uncovering repayment problems by calculating key earnings ratios and measures. One limitation of this ratio is that it is at one point in time, which may not identify a cash earning deficit during the year. To complement this financial statement analysis, a cash flow can be a useful tool to determine if sufficient net earnings are available to meet payments on a timely basis.

Financial statement analysis can utilize five key pieces of financial data, including net business income, non-farm income, family living and income taxes, principal and interest payments, and depreciation expense. This financial statement analysis data can be used to analyze the past as well as future earnings and can provide a means for a trend analysis. The procedure is the same whether one is doing a large commercial or agricultural loan or a small consumer credit request.

Sensitivity Analysis

In financial statement analysis, repayment analysis is not complete without testing the uncertainty that will frequent normal operations. This is particularly important in doing financial projections. The capital replacement and term debt margin is a measure that is useful in performing sensitivity analysis. This financial statement analysis is completed to determine if the smaller shocks of cost and interest increases and price decreases can be handled. For example, three basic financial statement analysis questions could be asked:

• First, how much could farm revenue decline before eliminating the margin holding expense and interest payments constant. If one divides the margin in total farm revenue, the business could withstand a certain percent decline in revenues without hindering the ability to repay or without eliminating the margin. A client or lender could take this one step further by applying it to various commodities produced, such as hog, dairy, corn, soybeans, beef, cotton, and fruit, to determine the break-even. This simple analysis can provide a price guideline that a customer can relate back to daily production and marketing decisions.
  
  
• A second financial statement analysis performed could be to ask how much costs could increase to eliminate the margin, holding revenues and interest rates constant.
  
  
• The third financial statement analysis part of the sensitivity analysis is to isolate the interest rate variable. A lender and client need to determine what portion of the total debt is on variable interest rates. If we assume all debt, say, $786,058 projected (debt to asset ratio), is on variable rates and if we hold revenue and other expenses constant, we would find that variable rates could increase by 14% over existing rates <$109,268 margin/$786,058 total debt>. If a client has less than a 5% sensitivity factor, a fixed rate strategy is suggested in the debt structuring arrangement.

A general financial statement analysis "rule of thumb" is that a business should exhibit an ability to handle a 5% decline in revenue, a 5% increase in expenses and a 3% increase in variable interest rates. However, if a business is in an expansion mode, is relatively new or is entering a new enterprise, it is suggested that the amount is doubled to 10-10-6.

Profitability Analysis

In financial statement analysis, larger enterprises frequently are concerned about repayment capacity, liquidity and solvency. Profitability is under emphasized. The need for profits in a commercial business is analogous to the importance of breathing to humans; it is a necessity, not an option.

Today one out of every five small businesses earns about 87% of net income. Businesses that are very profitable have a return on money greater than comparable investments in savings accounts and other investments with comparable risk. In agricultural financial statement analysis, the Farm Financial Standards Council recommends net farm income and three ratios be measured: return on assets, return on equity, and operating profit margin. The fourth of the five key ratios used in agriculture is any one of these key ratios or an earning trend in net farm income.

WebEquity calculates a complete financial analysis on any loan type, from the simplest loan requests to the most complex agricultural and related small business credits utilizing the Farm Financial Standards Ratios and RMA Industry Comparisons. Credit bureau reports can be pulled from within the WebEquity system and lenders can include that information in their scoring and rating parameters.

WebEquity also provides the Fair, Isaac LiquidCredit® analytic and decisioning service for small business lending, including the industry-leading Small Business Scoring Models^SM (SBSS^SM) functionality so lenders can quickly and confidently process loans up to $250,000 with little or no financial data.

Source: Financial Statement Analysis