Role of financial statement analysis in assessing credit quality

Credit analysis
Character – firm’s management reputation and history of debt repayment
Collateral – ability to pledge collateral can reduce lender’s risk
Capacity – for debts longer than 30 days, need to monitor the financial statement closely

Credit rating agencies
· Moody’s
· Stand and Poor’s

Categories to assess firm creditworthiness
· Scale and diversification – the greater, the better
· Operational efficiency – the larger, the better
· e.g. ROA, operating margin, EBITDA margin
· Margin Stability – indicate the probability of debt repayment
· Leverage – The greater earnings relative to debt and interest expense, the better credit risk