Page 18 - CIMA SCS Workbook February 2019 - Day 2 Suggested Solutions

SUGGESTED SOLUTIONS

ASSESSING CREDITWORTHINESS

Introduction
When a company (a borrower) is seeking to raise debt finance, the lender (for example the bank)
will carry out an assessment of the borrower to decide whether to lend. I have first explained the
general factors that lenders will consider, before applying these ideas to Vita’s current position.

Information presented by the borrower to the lender

In order to apply for the debt finance from a bank, a company will have to put together a business
plan. This will contain information such as:

• the purpose, amount and duration of the borrowing
• detailed cash flow forecasts, showing the likely cash flows of the borrower and aiming to
show the lender that the prospects for the borrower are good
• an explanation of how the borrower is proposing to repay the borrowing.

Assessment of creditworthiness by the lender

The lender will then carry out an assessment of the potential borrower by considering the
following information:

Analysis of business plan

The lender will perform a detailed analysis of the business plan. This will include detailed ratio
analysis of both the recent accounts and the forecasts.

The key objective of the lender will be to assess the borrower’s liquidity i.e. whether the cash
flows will be sufficient to make the interest and capital repayments.

The interest cover ratio will be particularly important since it gives an idea of how likely it is that
the firm will continue to be able to meet its interest payments even if profits fall.

Business prospects of the potential borrower

An analysis of the business plan will give the lender an initial insight into the business prospects of
the borrower. However, it will be important for the lender to carry out further analysis in an
attempt to build up an independent assessment of the borrower’s prospects. For example, the
lender will assess:

• the quality and track record of the borrower's management
• the risk profile of the company
• the prospects for the industry sector – e.g. competitor growth, market share trends etc.

Security available

The lender will look at the borrower’s statement of financial position to assess whether there are
assets that could be used to provide security. Lending the money secured on assets would
significantly reduce the lender’s risk.

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