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To create, cultivate and promote professional and healthy credit culture.

To establish lifelong relationship between the Bank and its customers through satisfying the actual need of the later.

To make the Bank’s credit operation as well as decision prudent.

Meet the credit needs of customers through providing proper advice and consultancy on the credit standards of the Bank and proper business management and book of recording.
To bring a paradigm shift in the attitude - Helpful and friendly banker, usually Banker considered as risk averter- So in our current situation need to have wide risk appetite
To help realize the mission and vision of the Bank
All persons engaged in lawful trading activities.
Non-trading government/public institutions will be eligible depending on their nature and strategies.
All persons who have defined and sustainable source of income are eligible to borrow consumer loans.
The business/credit applicant should present renewed trade license for the current fiscal year or investment license and principal registration certificate for new projects.
All applicants who are engaged in business must present a tax identification number /TIN/ or tax exemption certificate for all of their income.
The applicant and/or any of its shareholders/subsidiaries shall fully settle any previous loss loan to the Bank, if any. To this effect, internal records shall be thoroughly checked
For loans that show irregular pattern of repayment, the following additional steps are applied:
Following-up the end use of disbursed loan, debt servicing and early warning signals.
Preparing early intervention/remedial action proposal on problem loans.
Making decision on early intervention/remedial action proposal.
Communicating the decision to customer.
Amending loan/mortgage contract.
Following-up the performance of the customer's business and loan account.
Ensuring full collection of loans and advances.
For loans that are categorized as “Non Performing Loan” as per relevant directive of National Bank of Ethiopia, the following additional steps are applied:
Transferring problem loans to Loan Recovery Team.
Setting of negotiation and resolution strategies.
Negotiating with customer.
Searching for attachable properties.
Preparing and presenting loan recovery resolution proposal.
Checking and commenting on the loan recovery resolution proposal.
Making decision on loan recovery resolution proposal.
Amending loan/mortgage contracts.
Foreclosing and collecting of sales proceeds.
Instituting litigation against defaulter and selling property through court.
Following-up of loan recovery/settlement.

Intensity of the credit and risk analysis may vary based on the nature of credit request; type of the business the customer is engaged in; and level of associated credit risk;
In case of existing borrower(s)/customer(s), the Credit Risk Analysis Report shall concentrate on new developments of the business and summarized on a few pages as far as possible;
To properl

1. CREDIT ANALYSIS OCT, 2023 10/18/2023 1

2. Overall Objectives To help and expedite the HRD strategy To enable all performers to have uniform understanding of the credit processing based upon the credit culture of the bank. To enhance efficiency and effectiveness of Credit process, especially credit appraisal and follow-up. To enhance adherence to an established principles on Know Your Customer (KYC), credit policies and Procedures. To maximize quality credit portfolio. 10/18/2023 2

3. Objectives Cont…….. To create, cultivate and promote professional and healthy credit culture. To establish lifelong relationship between the Bank and its customers through satisfying the actual need of the later. To make the Bank’s credit operation as well as decision prudent. Meet the credit needs of customers through providing proper advice and consultancy on the credit standards of the Bank and proper business management and book of recording. To bring a paradigm shift in the attitude - Helpful and friendly banker, usually Banker considered as risk averter- So in our current situation need to have wide risk appetite To help realize the mission and vision of the Bank. 10/18/2023 3

4. Objectives con… To start a new era of Lending where there is a need to: Assess the need-Based Credit of a borrower on a RATIONAL Basis- Based on their business plan or financial statement. To ensure proper end-use of Bank credit- Bring Rational Mgt of Fund by customers To improve the financial discipline of a borrower, Bank Credit is a supplement, 100% finance is not recommendable Banker has a role to improve the operational efficiency of Borrowers, and at National wide also To develop healthy Banker-Borrower R/ship(KYC) 10/18/2023 4

5. Getting the Big Picture 10/18/2023 5

6. Themes & Results Perspectives Strategic Objectives Business Growth : Sustainable profit and Enhanced Role towards National Development Operational Excellence : Satisfied Stakeholders Financial and Developmental Ensure Sustainable Profitability Increase Financial Resource Mobilization Enhance Developmental Financing Ensure Financial Soundness Customer Increase Customer Satisfaction Expand the Customer Base Internal Business Process Enhance Accessibility of Services Improve process efficiency and effectiveness Improve Risk Management Learning & Growth Improve Employee Satisfaction and Engagement Enhance Information Systems Enhance Human Resource Development Enhance Internal and External Communication 10/18/2023 6

7. Cont.. Vision To Be a World Class Commercial Bank by the year 2025. Mission We are committed to realizing the needs of stakeholders through enhanced financial intermediation globally, and supporting national development priorities by deploying highly motivated, skilled and disciplined employees as well as state-of-the-art technology. We strongly believe that winning the public confidence is the basis of our success. 10/18/2023 7

8. Cont.. Values Integrity Customer Satisfaction Employee satisfaction Learning Organization Teamwork and Collaboration Public Trust Value for Money Decentralization Corporate Citizenship 10/18/2023 8

9. Credit Analysis critical assessment of creditworthiness of a borrower; identification of anticipated risks and setting risk mitigating measures depth of the credit analysis depends on nature of the request, type of business and the associated credit risk; 10/18/2023 9

10. General Eligibility Criteria for a Loan All persons engaged in lawful trading activities. Non-trading government/public institutions will be eligible depending on their nature and strategies. All persons who have defined and sustainable source of income are eligible to borrow consumer loans. The business/credit applicant should present renewed trade license for the current fiscal year or investment license and principal registration certificate for new projects. All applicants who are engaged in business must present a tax identification number /TIN/ or tax exemption certificate for all of their income. The applicant and/or any of its shareholders/subsidiaries shall fully settle any previous loss loan to the Bank, if any. To this effect, internal records shall be thoroughly checked 10/18/2023 10

11. Cont.. The applicant must have never been engaged in tax evasion; The applicant must not have any record of mal-operation of the checking account ; The applicant shall fulfil at least the required minimum equity contribution; The applicant has to present all the documents/information demanded by the Bank. The applicant’s business must be financially viable, legally acceptable, technically feasible and environmental friendly; 10/18/2023 11

12. The Credit Process For regular loans, Credit Origination Interview Collecting Credit Processing Documents & Information Collateral Estimation Credit Analysis & Approval Decision Communication, Contract Preparation & Loan Disbursement Documentation & Regular Follow-up Filing of loan and security documents/information. Monitoring of periodic loan repayments/amortizations/utilizations. 10/18/2023 12

13. cont For loans that show irregular pattern of repayment, the following additional steps are applied: Following-up the end use of disbursed loan, debt servicing and early warning signals. Preparing early intervention/remedial action proposal on problem loans. Making decision on early intervention/remedial action proposal. Communicating the decision to customer. Amending loan/mortgage contract. Following-up the performance of the customer's business and loan account. Ensuring full collection of loans and advances. 10/18/2023 13

14. cont For loans that are categorized as “Non Performing Loan” as per relevant directive of National Bank of Ethiopia, the following additional steps are applied: Transferring problem loans to Loan Recovery Team. Setting of negotiation and resolution strategies. Negotiating with customer. Searching for attachable properties. Preparing and presenting loan recovery resolution proposal. Checking and commenting on the loan recovery resolution proposal. Making decision on loan recovery resolution proposal. Amending loan/mortgage contracts. Foreclosing and collecting of sales proceeds. Instituting litigation against defaulter and selling property through court. Following-up of loan recovery/settlement. 10/18/2023 14

15. cont Re-transferring cases to regular loans category. Preparing write-off proposal on impaired loan. Making decision on write-off of impaired loan proposal. Communicating the write-off decision to concerned branch. Adjusting accounting records. Conducting post write-off follow-up. 10/18/2023 15

16. CHAPTER TWO CREDIT ANALYSIS Credit and Risk Analysis refers to a critical assessment of a business entity to see whether it is strong enough to warrant lending of money to it, and related risks. It is generally done to assess the creditworthiness of a borrower and involves examining the ability of a borrower to repay debt of some kind. 10/18/2023 16

17. Credit analysis source documents Due diligence report of the CRM ; Credit Application Form (CAF) and Customer’s application; Financial statements; Credit database of the Bank and/or market data (to be collected by the credit analyst), such as industry-wide profitability, liquidity and leverage ratios, portfolio concentration (by sector, ownership, product and geographic area), macro- and micro-economic data, market situation, market share, where applicable, intensity of competition, industry characteristics, business cycle, etc.; Supporting documents; Range of accounts/overdraft utilization/ account performance; Credit information report; Legal opinion; and Other pertinent sources. 10/18/2023 17

18. Depth of Credit Analysis/Appraisal: … Intensity of the credit and risk analysis may vary based on the nature of credit request; type of the business the customer is engaged in; and level of associated credit risk; In case of existing borrower(s)/customer(s), the Credit Risk Analysis Report shall concentrate on new developments of the business and summarized on a few pages as far as possible; To properly analyze/appraise the credit request the lending officer shall gather adequate information; The CRM is responsible to gather the required documents/information; 10/18/2023 18

19. Credit Negotiation before final pproval The CRM can negotiate with the customer on items like tenure, disbursement arrangements, repayment terms, collateral issues and covenants etc... prior to final decision by the approving team. 10/18/2023 19

20. Content of Credit Analysis The content of the credit analysis/appraisal shall follow the analysis format of the Bank to ensure a standardization and uniformity. The basic components of the analysis format are explained below: 10/18/2023 20

21. Basic Information of Applicant Customer Name and address; Date of Business establishment; Date of relationship established with the Bank; Customer classification s; Ownership or Business Formation; Economic sector; Business type; Type of financial statement presented; Customer’s Credit Grade Risk; 10/18/2023 21

22. Credit Risk Grading /Rating The Credit Risk Grading – CRG is collective definition based on the pre-specific scale and reflects the underlying credit-risk for a given exposure; Used to develop credit risk management system; The system should define the risk profile of borrower’s to ensure that account management, structure and pricing are commensurate with the risk involved; 10/18/2023 22

23. Purpose of the Rating/Grading To assist credit decision making process, To help in monitoring and controlling the quality of loans and advances; To timely manage early warning signals ; To maintain application of uniform credit risk rating/grading standards; To help in setting loan pricing and maintain appropriate level of loan provisioning . 10/18/2023 23

24. Content of credit risk grading Financial Risk/ strength of financial management system – to determine the adequacy of the financial management and financial position, measured in parameter of Leverage - Liquidity Profitability - Debt service coverage 10/18/2023 24

25. Content..... Quality of the financial statement Composition of the recent three years financial statement provided with respect to the credit exposure Negative value ( auditor’s qualified opinion either as major or minor discrepancies) 10/18/2023 25

26. Cont.... Business/Industry risk Business/industry outlook Market competition/market share Management risk Experience of the management Qualification of the management Succession plan 10/18/2023 26

27. Cont... Account performance risk Overdraft( highest debit, lowest balance and turnover) Term loan (settled and existing term loans) Facility-ML,OD, Pre-shipment, Revolving export credit (turn over and settlement condition) Letter of guarantee( settlement without claim or after claim) Negative value Settled by converting to other forms of loan or selling of collateral or loan sell out 10/18/2023 27

28. Cont.... Customer relationship risk Length of borrowing relationship Integrity honesty and co-operation 10/18/2023 28

29. Linked Lending Shareholders in the applicant company having 50% or more stakes in a related/sister company or having shareholders of first degree consanguinity a major shareholders, shall take the credit risk rating of the parent company, or the related/sister company, or company being graded/rated (the applicant), whichever is the worst grade/rate. 10/18/2023 29

30. Credit Exposure The credit exposure of the applicant with Siinqee Bank is computed by taking the outstanding balances of term loans and the limit of the credit facilities. Similarly of the sister company’s credit exposures should be clearly computed. The grand exposures calculated as a summation of the applicant’s and sister company exposure. The grand total exposure should be within a single borrower limit, as stipulated in NBE directive SBB/53/2012. 10/18/2023 30

31. Cont… Auditor : the auditor must have a license and among registered auditors and should be in the list of acceptable auditors by government body Procedure exception : the loan approved by the variation from the Credit Process Procedure but within the spirit of the credit policy and procedure. Approving Team : The processed credit request shall be forwarded to approving team based on the discretion limit assigned to respective team. If the request is an appeal or have exception component, the case will be forwarded to one committee higher of the discretion limit of the committee . 10/18/2023 31

32. Credit Request Content of the credit request The content of the credit application varies depending on the nature of requests. For instance, the request of the applicant shall either be for a fresh term loan- or credit facilities like an O/D facility, L/C facility, pre-shipment export credit facility, L/G facility or renewal of credit facilities. 10/18/2023 32

33. The content of the credit application The content of the credit application shall at least include The type of the credit product requested The amount requested Period of borrowing and repayment term The type of collateral and the owner of collateral offered Purpose of the credit request Grace period, if necessary Source : ( Credit application, CAF, business plan and feasibility study) 10/18/2023 33

34. Elaboration of Terms Type of loan : refers to type of credit products such as term loan, overdraft, pre-shipment export credit facility, letter of credit, letter of guarantee, or other credit related request. Amount requested : refers the loan amount requested which is directly taken from the application letter and CAF filled by the applicant. There are requests which do not involve amount such as, collateral release, collateral replacement, lifting of conditions etc… Period of borrowing ; this is the time required by the borrower to repay the loan or the renewal period. It can be inferred from the application letter and/ or CAF filled by the borrower. 10/18/2023 34

35. Cont... Repayment term : this refers to mode of repayment of the loan and it varies depending on the nature and cash flow generation of the business from the business. Repayment term could be on monthly, quarterly, semi annually, annually or at maturity (lump sum). Grace period : depending on the cash flow pattern of the borrower, the bank may consider the grace period, in the light of the cash generating lag. 10/18/2023 35

36. Purpose of the Request The purpose of the request is deduced directly from the applicant’s credit application letter (such as working capital, project financing, change or replace or release collateral etc). The applicants shall clearly and concisely indicate the end use of request and reason for choosing the specific credit products. The purpose should be substantiated by business plan with the breakdown of working capital need or feasibility study or other relevant document depending on the nature of the request. ( Source : Credit application, CAF, business plan and feasibility study) 10/18/2023 36

37. Collateral Key components: description of the type, name of owner, location, type of evidencing document (like LHC, booklet) with ownership certificate number ,plate number, value estimating body, estimation date, year of make (machinery and vehicle) gross estimation value, net estimation value( if there is remark on the building estimation or discounted/deduct the depreciation) Source: from estimation format, letter of guarantee, authenticated foreign bank guarantee, bond certificate and other documents. 10/18/2023 37

38. Types of Collateral The type collateral offered should be acceptable per the bank’s Credit Process Procedure. Some of the acceptable collateral are building, vehicles, machinery, construction machinery, agricultural machinery, bank guarantee, negotiable instrument (Treasury bill, government bond), cash deposit, merchandise, business mortgaged, land lease right, coffee plantation and other form of collaterals . If building is offered as collateral, it can be of private or public and it can be with the state of use of residence, office, store, factory building or others. If vehicles, it can also be automobile, trucks, trailers, bus and so on, the bank also accepts construction machinery like excavator, dozer, grader, loader, roller, crusher and others as well agricultural machinery like tractors, combine harvester, coffee pulping and others. 10/18/2023 38

39. Types of Collateral Merchandise shall be held as collateral only when credits are to be extended in the form of merchandise loans its value must be determinable; easily marketable/fast moving, the price must be relatively stable; the product should not be perishable; and the product must be insurable. Business mortgage is a security arrangement whereby loans and advances are approved against security of the corporeal and incorporeal element of business entity. The corporeal elements of a business mortgage are those that are tangible and may consist of building, motor vehicles, equipment, machinery, goods and other movable items. The incorporeal elements of a business mortgage include goodwill, trade name, and trademark, the right to lease the premises in which the trade is carried on, patents, copyrights, and other special rights attached to the business itself. 10/18/2023 39

40. Types of Collateral The bank shall accept the coffee plantation and the land lease right of the applicant to be held as collateral. A Foreign Bank Guarantee refers to a written undertaking issued by a foreign bank as a guarantor of the borrower, stating its legally binding commitment to pay on demand and without any contestation a sum equal to the value of the guarantee to the bank in the event of default by the borrower. While accepting the bank guarantee, legal advice or opinion should be obtained from Attorney of the Bank; Cash in form of saving deposits, demand deposits and time deposits in any branch of the Siinqee Bank. A letter of consent from the customer that authorizes the Siinqee Bank to have all rights on the account must be filled and presented as per the standard format of the Bank. Such deposits shall be blocked until the loan is fully settled. 10/18/2023 40

41. Types of Collateral Negotiable Instruments including treasury bills and government bonds. Treasury bills represent short-term financial papers/instruments commonly issued at defined denominations by Government Treasuries. Government Bonds Government Bonds represent interest bearing certificates issued (sold) by government. 10/18/2023 41

42. Verification of Pertinent Points in Collateral The Siinqee Bank’s lending system is cash flow oriented , however, if the applicant fails to meet his/her/its obligation, collateral is deemed as a second way out. Exhaustive List of collateral corresponding to the type of loan mortgaged must be indicated and the completeness of the document must be ensured The name of the owner of the collateral, the state of the present use shall be deduced from provided evidencing document, the genuineness and completeness of the evidencing document (ownership certificate, title deed, approved plan, lease agreement and other relevant document) need verified by the bank engineer. 10/18/2023 42

43. Verification cont.... The analyst also needs to go through the physical condition, instalment and technical condition assessment of the machinery and vehicles. If the offered collateral is the lease right, the analyst should go through the lease agreement and inquire legal comment, if necessary The offered collateral shall be registered with legal empowered governmental body, however, not all acceptable collaterals are registered like bank deposit, financial instrument, merchandise, bank guarantee, and written undertaking from the Federal Government, Corporate/personal guarantee and others shall not be registered. 10/18/2023 43

44. Verification cont... Second degree mortgage is not acceptable by the bank; The analyst shall cautiously go through the remark stated by the bank engineer like The name of ownership on the LHC vary from the name on the approved plan, The building construct out of the LHC If approved plan is not presented The implication of the bank’s engineer remark given on property estimation on collateral should thoroughly assess. 10/18/2023 44

45. Verification CONT..... Assess the location of the collateral in terms of effect on Market value of the collateral ( the bank engineer indicates this condition in the market condition factor) and stability of the realizable value and convertibility to cash when desired; The analyst should inquire legal opinion about collateral like bank guarantee, and for other collateral ,if necessary Status of stock( for merchandise loan) as checked by the CRM; If the collateral is foreign Bank Guarantee must be authenticated by Trade service, Bank Risk grade should be checked based on Standard and Poor rating or equivalent of Moody’s or Fitch latest rating (source latest Banker Almank and confirmed by the Trade Service) and the analyst make sure that the guarantee fulfil the grade that the CPP as well the NBE require; 10/18/2023 45

46. Verification CONT.... The analyst should verify the timely revaluation of the collateral per the credit Process Procedure; The analyst shall verify the vulnerability to obsolescence, especially machinery; Insurability, registration and transferability are checked based on the CRM information; 10/18/2023 46

47. Value of Collateral Gross Collateral Value The Gross value of the building, machinery and vehicle from the bank engineer estimation, which is made per the collateral Valuation Procedure; If the building under construction offered as collateral, it can be considered only if 50% and more is completed; For the machinery and vehicles, at the first year of estimation gross value is considered, but for the following years the value should be adjusted by the level of depreciation; 10/18/2023 47

48. Value cont... If the motor vehicles and machinery are imported final invoice of cost and CIF value, custom clearance cost, inland transportation shall be considered; For cash deposit, the value will be deduced from the certificate of deposit; For the guarantee, the value shall be taken from the letter of guarantee issued by the guarantor; For the financial instrument, the face value of the instruments are considered; For the merchandise (imported goods, locally manufactured goods and agricultural products) and other forms of collateral based Credit Process Procedure; Other form of collateral based collateral like business mortgage, 10/18/2023 48

49. Value cont.... The collaterals, requires to be estimated by the bank engineer; If the loan is unsecured by the offered collateral, the analyst should check the eligibility for the unsecured loan; Net Collateral Value The net collateral value of the collateral will be adjusted as follows For computation of the net collateral value of the collateral, the remark pointed out and the engineer and the implication are used, based on the effect, the analyst compute the net collateral value; 10/18/2023 49

50. Value of Collateral For the vehicles, machinery and corporal element of the business mortgage, the value should be adjusted considering of the depreciated value effective the date of estimation; Based on year of manufacturing , the value of automobile and truck will be excluded, as per the bank’s credit procedure. Security to loan ratio The strength of the collateral offered to extent of loan coverage measured by the security to loan ratio; For the existing loans, the outstanding balance of the term loan and the facility limit shall be taken to calculate the loan amount; 10/18/2023 50

51. Value cont... The analyst compute this ratio by considering the gross as well the net value of the collateral, these collateral value with respect to the existing loans, including his/her recommendation and considering of the applicant request in different scenarios; The analyst shall examine the minimum collateral coverage requirement for the respective Credit Risk grade per the CPP; 10/18/2023 51

52. Establishment, Management and Nature of the Business Establishment The date of establishment; The owner of the business, if it is a company and partnership, from the registered article and memorandum of the company and the respective share contribution; Background information of the owner of the business and experience on the line of business and qualification. The role of the owner in the business and plan on the successor of the ownership . Profile of the sister company: The owners of the sister company with their respective share value Line of business 10/18/2023 52

53. Establishment, cont… Profile of the major shareholder of the company and other related companies: The major shareholder share profile of in other related company Line of business it engages Source: business license, Article and Memorandum of Association, business plan and due diligence report. 10/18/2023 53

54. Legal and Other Issue The legal personality and related issues shall be checked by the legal attorney; The empowerment of the appointed person/persons to enter loan and mortgage contract shall also be collected from the legal attorney; The analyst can also inquire opinion legal comment collateral related issues, including of bank guarantee, lease right, and other collateral related cases, if it needs to be supplemented by the attorney legal opinion. The analyst shall also inquire legal comment on tax clearance as well tax exemption condition, if necessary. Depending of the nature of request, the analyst can inquire on the issues which demands legal comments. 10/18/2023 54

55. Management of the Business The management issue includes at least the following points: The profile of the Board of the management, if the company has such form of supervising authority. The authority and delegation role of the Board of Management, like appointment of a person who enter loan and mortgage contract and issues need to be asses based on the registered and authenticated Article and Memorandum of Association; Registered and authenticated Minute of Board of Management on the amendment of Article and Memorandum of association, on the delegation of authorized person to run the business and other related issues; The profile of the management supported with evidentiary document on the qualification and level of experience, should be part of the applicant document along with the summery of the management list with respective position. The analyst reproduces into the profile based on the presented document. 10/18/2023 55

56. Management with 5 c’s 10/18/2023 56

57. Nature of the Business The business purpose is inferred from authenticated and registered Article and memorandum of association, if the applicant is a PLC or share company. The specific line of business which the applicant currently engages is considered, based on the trade license and/or investment permit business field. The nature and background information of the business, location, overall performance (like total export performance), type of the machinery and equipment, capacity (ideal and current operation capacity of the machinery), trend of production and shift of operation, the number of staffing and other related information related with business can be included in this section. The availability of side business, the overall performance of these side business, the link either as forward or backward linkages, complimentarily or independence and other related issues are also review. 10/18/2023 57

58. Nature of the Business If there is sister companies, the business line and the overall business performance should be assessed in brief. The analyst also needs to identify the current market situations of the specific business and overall economic sector. Factors which affect the business condition and any challenges on the business operation (like problem of infrastructure, access to market, sustainability raw materials and availability of trained and skilled manpower) shall be incorporated in business analysis. The analyst also expects to include any possible business risk. Source: business license, Article and Memorandum of Association, business plan, due diligence report and other internal and external information source. 10/18/2023 58

59. Key Customers and Suppliers of the Business: Identify the main customers and suppliers of the business and comment on the availability of sufficient suppliers and buyers based on the information obtained from CAF and file (like sales agreement and purchase agreement). 10/18/2023 59

60. Credit Exposure The credit exposure of the applicant both with Siinqee Bank and other banks shall be taken from the LAF, statement of loan accounts and credit information response. Similarly, the credit exposure of the sister company, the major shareholders and other affiliated companies with Siinqee Bank and other banks are also incorporated in this section based on the due diligence report and credit information response The key components in analysis of the credit exposure are the approved amount/limit, outstanding balances, date granted, due date and the status. The analyst should critically assess the status, repayment habit, utilization of the facility based on the presented document and verify whether the performances are in line with the bank’s credit process procedure and NBE directives. 10/18/2023 60

61. Credit Exposure If company, the credit exposure of the sister company( the sister company definition based on the NBE directive) should be added to indicate the total credit exposure and to check whether it is within the single borrower limit per the NBE directive. The analyst should check whether the major shareholders/subsidiaries fully settle the previous loss loan, if any The analyst should check whether the major shareholders/subsidiaries have non- performing loan Source: information statement of loan account, MIS report, LAF, CAF and due diligence report 10/18/2023 61

62. Borrower’s Loan Account Performance Each loan account performance shall be assessed separately and in detail; some of the credit products performances are measurement of performance are presented beneath with the respective type of the credit products: 10/18/2023 62

63. Types of the credit products: Term loan, A Term Loan is a loan granted for working capital and/or project finance to be repaid within a specific period of time with interest. The loan is repaid in a lump sum on maturity, or in periodic instalments (i.e. monthly, quarterly, semi-annually, or annually), depending on the nature of the business and its cash flow. The Bank extends Short-Term Loan, Medium-Term Loan and Long-Term Loan; 10/18/2023 63

64. Types of the credit products Short-Term Loan: Short-Term Loan is a loan extended by the Bank to finance the working capital needs and/or to address other short-term financial constraints of the borrower’s business. Short-Term Loan could be granted up to a maximum of three years. Medium Term loan: A Medium-Term Loan is a loan which has a maturity period longer than three years, not exceeding a maximum period of seven years, Long term loan: A Long-Term Loan, on the other hand, is a loan which has a maturity period longer than seven years but not exceeding a maximum period of 15 years. 10/18/2023 64

65. Types of the credit products Medium- or Long-Term Loans for projects/businesses whose nature justify, or require, such periods of time for implementation and repayment of the loan. These types of loan are intended for the financing of the acquisition and/or leasing of fixed business assets (leased land, buildings, machinery, equipment, vehicles, trucks and trailers, etc.), the establishment of a new project and the expansion of an existing business—all of which must be justified by a project feasibility study 10/18/2023 65

66. Cont… Grace period is a period during which the borrower is relieved from principal repayments. Depending on the nature and cash flow of the business, the Bank may provide a different grace period. In measuring of the performance of term loans, the analyst approached as settled and existing term loans: 10/18/2023 66

67. Cont… Settled term loan - the different term loan granted and settled shall be measured taking into account the range of amount granted and settlement condition, either settled with regular repayment, settled timely but with element irregularity, settled within thirty days after the due date, settled between 30 to 89 days after the due date, settler after NPL/through legal action etc... 10/18/2023 67

68. Cont… Existing term loan- here only term loans that have currently outstanding balance are assessed. The analyst expected to include the amount granted, purpose, date granted, due date, status of the loan per the NBE directive, and measure the performance as the regularly repaid, if the loan incur arrears, categorize the arrears as 1-30 days arrears, 31-60days arrears and more than 60days arrears. Source: information statement of loan account, MIS report, LAF and due diligence report 10/18/2023 68

69. Cont.. Overdraft (O/D) An Overdraft is a form of credit facility by which a customer may be allowed to draw beyond the deposits of its current accounts for the sole purpose of the day-to-day operational needs of a viable and ongoing businessman Overdraft facility is repayable on demand. The facility has pre-determined limit and renewal. The Bank shall call-back the outstanding Overdraft loan balance at any time when its performance is unsatisfactory. In the case of measuring the performance of an O/D the following parameters should be assessed: 10/18/2023 69

70. Cont.. Turnover, the frequency of the facility turned over, it is computed dividing of the summation of the debit balance of a month to the limit of the facility, and add the monthly turnover to get the annual turnover. High turnover implies good utilization of the facility. Highest debit swing of an O/D account- take the highest value of the facility utilized for the tenure under consideration and put in terms of percentage of the ratio of the facility limit. Lowest debit of an O/D account or highest credit balance - showing how the facility is stretched to lowest debit balance or credit balances, the lowest debit balance computed by taking the lowest debit balance of the facility as the ratio of the facility limit 10/18/2023 70

71. Cont.. The analyst should also check the fulfilment of the NBE directive in terms of lowest debit balance. The analyst should critically assess whether the performance of an O/D is in line with cash flow of the business. The analyst should critically assess existence of hard core or not, inquire justification if there is of hard core(like diversion of an O/D or the change in business condition) and resolving mechanism If the facility is not satisfactorily utilized, suggest on the possibility of reduction of the limit or if totally or hardly utilized comment on the possibility of cancellation of the limit S ource: Range of Account/Overdraft Utilization Worksheet). 10/18/2023 71

72. Cont. Letter of credit (L/C) The import letter of credit facility is a credit product that the bank extends to applicants engaged in the import business, or other applicants who import for various purposes on payment of a certain percentage of the value of the document while opening a L/C. It is form of payment promise of the bank to the exported made by a bank on behalf of the importer who pays certain margin of the value of goods against the receipt of import documents. The bank transfer the ownership the import document upon collecting the remaining amount and interest there on from the importer. The L/C facility can either be of one time (non renewable) or revolving which can be utilized by turning over of the limit and renewable. 10/18/2023 72

73. Cont… The important points to be considered in L/C Key components to be included for measuring the performance of L/C are L/C opening and settlement date, advised date, the L/C opening balance both in terms of foreign currency and local currency, nature of imported items. The analyst should critically assess the purpose of the L/C and check whether the facility has been utilized only for the intended purpose. To show the utilization of the facility, the analyst shall assess the total amount of L/C opened during the reviewed period with respect to the facility limit in order to measure the utilization and turnover. 10/18/2023 73

74. Cont.. The number of L/C opened and settled, disregarded the cancelled L/C. The settlement condition of each L/Cs as settled within a week, within three weeks, within a month and after a month, if there are L/C settled after weeks or being outstanding for the long period, the analyst should inquire justification and comment on the settlement condition Source: Trade service, the branch report and MIS 10/18/2023 74

75. Cont… Merchandise loan Merchandise refers to a specific product or group of products or goods manufactured or acquired by a trading business for the purpose of sale. A Merchandise Loan is a short-term credit facility provided by the Bank against which the merchandise or documentary evidence. The merchandise loan can be for one time and revolving merchandise loan. The revolving M/L renew periodically prior to maturity where as the one time avail only up to the facility mature. 10/18/2023 75

76. Cont.. The performance of the M/L is measured in terms of turnover, which is computed by dividing by summation of the amount of settled M/L at the review period to the facility limit. The sum of each advance at a time can be stretch up to the approved facility limit. The analyst expect to put in as summery, each advances, date grant and settlement date and check the sum advances is not over the granted limit The settlement condition of each advance should be also need to assess. The analyst assess the physical condition of the stock based on the CRM due diligence report Source: statement of merchandise loan facility 10/18/2023 76

77. Cont… Pre-shipment Export Credit Facility Pre-Shipment Export Credit Facility is a loan extended for purchase of raw materials, processing and converting them into finished goods, warehousing, packing and transporting the goods until the time of shipment. The pre-shipment export credit facility can be one time or revolving, and it is granted against sales contract. The sum of advance shall not exceed the approved limit The performance of the pre-shipment is measured in terms of turnover of the facility which is computed by dividing the sum of advances during the tenure by the facility’s limit. Compare the proceeds to total value credited to loan account for the settlement of different advances The settlement condition of each advance should be assessed. Source: (the statement of facility MIS and credit advices of receipt of proceeds) 10/18/2023 77

78. Cont… Revolving Export Credit Facility Revolving Export Credit Facility is an advance extended to exporters after the shipment of export items and it is advanced upon presentation of acceptable export documents, except a bill of lading. The facility should be advanced against valid export documents and will be settled from the proceeds of the export. 10/18/2023 78

79. Cont.. Letter of guarantee A letter of guarantee facility issued by a Bank is a written promise/ irrevocable obligation by the Bank to compensate (pay a sum of money) to the beneficiary (local or foreign) in the event that the obligor fails to honour his/her/its obligations in accordance with the terms and conditions of the guarantee/agreement/contract. There are different forms of letter of guarantee such as Bid bond , Performance Bond , Advance Payment , Supplier’s Credit , Retention Guarantee , Custom Duty Guarantee and Steamers Guarantee . The Letter of Guarantee either be one time or renewable The duration of the guarantee instrument depend on the contractual agreement signed by the parties involved in guarantee contract. The analyst should check whether settlement of the letter of guarantee, as a beneficiary has claimed or not for issued guarantee during the given period. Source: due diligence report and LAF 10/18/2023 79

80. Cont.. Customer’s Deposit Performance Creation of integration between credit and resource mobilization efforts of the Bank is one of the major recent focus areas of our Bank. Among the methods for creation of this integration is to ensure that credit customers of the Bank transact their sales through our Bank’s branches. Hence, existing borrowers of the Bank are expected to channel at least 95% of their sales through our Bank if the customer has credit relationship only with our Bank or proportional amount thereof if the customer has also credit relationship with other banks. Source: Deposit account transaction summary from branches, financial statements (for sales) 10/18/2023 80

81. Condition of Fixed Assets Analyze the age and condition of fixed assets (Buildings, Machinery, equipments, etc.) owned by the business. Any addition or disposal of asset based on the financial statement. Identify any plans for asset replacement or expansion over the next years. This information shall be gathered from due diligence report and business plan. 10/18/2023 81

82. Financial Statement Analysis Financial Analysis Meaning and Importance Financial statement analysis is a process of synthesis and summarization of financial statements and operative data (presented in financial statements) with a view to getting an insight into the operative activities of a business concern; Financial statement analysis is a technique of investigating the financial positions and progress of the unit, by establishing some relationship between balance sheet and income statement . It is also an attempt to reveal the meaning and importance of various items contained in the financial statements . An analysis of financial statements gives a general picture of business operations and their impact on the financial health of the business. 10/18/2023 82

83. Cont.. Generally, financial analysis using financial statement of a business entity is one of the integral parts of credit processing and analysis. It is the process of selection and evaluation of financial information; Selecting from among the total information available about a business enterprise; Arranging the information in a way that will bring out significant relationship; Studying these relationships and interpret the result; 10/18/2023 83

84. Importance of Financial Statements Financial statements are the index of the financial affairs of a company. It can be viewed differently by various users; To the management of the business - can use as means of self-evaluation. To the bank -assess the liquidity positions of the client firm and determine the credit worthiness; To investor in knowing the safety of his/her funds and the possible returns of same. To the economist can gauge the extent of concentration of economic power and lapses in the financial policies. The employees and trade unions can know how the firm stands in relation to labour and its welfare. To the Government relating to licensing controls, price fixation, ceiling of profits, dividend freeze, tax subsidy and other concessions. 10/18/2023 84

85. Procedures for Financial Analysis Re-organizing financial data For the purpose of financial analysis, we have to re-organize and re-arrange the data contained in financial statements. The data may be grouped and re-grouped on the basis of resemblances and affinities into categories of a few principal elements; Through such classification and re-classification the financial statements will be recast and presented in a condensed form. The changed arrangement of items will be different from the original financial statements; The analysis of financial data i.e., classification of the data into groups and sub-groups and establishment of relationships among them, is followed by interpretation; 10/18/2023 85

86. CONT... Interpretation The term interpretation means explaining the meaning and significance of data , so simplified. It involves drawing inferences from the analyzed data about the different aspects of the operational and financial results of the business and its financial health; Analysis and interpretation are closely inter-linked. They are complementary to each other. Analysis without interpretation is useless and interpretation without analysis is impossible. But, generally, the term analysis is used to include synthesizing, summarizing as well interpretation , since, analysis is always aimed at interpretation of the relationships that are established in the course of analysis; 10/18/2023 86

87. CONT… Points to be considered by the analyst: Accordingly, during financial analysis, analysts should understand the following features of financial statements. Financial statements are organized summaries of detailed information. Therefore, the document provides full information about the business entity; Items in the statements and their standard of disclosure are influenced by the issuers’ desire to provide complete information or not; Analysts should concentrate on essential or key amounts and relationships to find out why the conditions revealed by the financial statements existed. 10/18/2023 87

88. CONT… Apart from the above, it is crucial to know the following facts in order to understand financial statement. The facts are: - Accounting policies; Subjectivity of assets valuation; The underlying business and the non – financial information. Likewise, financial statements are prepared based on some assumptions; and are subjected to judgments and estimates. At the same time, they provide valuable information about the business entity that is relevant to financial analysis and decision making. 10/18/2023 88

89. CONT… There are five fundamental concepts followed in preparing financial statements and need to be understood by users of the statements . The business entity concept: - Business financial information is recorded and reported separately from the owner’s personal financial information; The going concern concept: - Financial statements are prepared with the expectation that a business will remain in operation indefinitely; 10/18/2023 89

90. CONT… The accrual concept (matching principle): - Revenue from business activities and expenses associated with earning that revenue are recorded in same accounting period; The consistency concept: -In the preparation of financial statements, the same accounting concepts are applied in the same way in each accounting period; and The concept of prudence (conservative principle): when there are alternative accounting methods that could be applied to a transaction or an account balance, it is generally recommended to apply the one that leads to lower income or lower asset value. For example, lower of cost and net realisable value for inventory valuation. 10/18/2023 90

91. CONT… Objective of Financial Analysis The main objective of financial analysis is- To reveal the fact and relationships among the managerial expectations and the efficiency of the business unit; To measure a financial strengths and weaknesses , its credit worthiness can also be known through such an analysis; To identify the safety of funds invested in the firm, the adequacy or otherwise of its earnings, the ability to meet its obligations etc. Prediction has to be made based on past trend; 10/18/2023 91

92. Financial Analysis Methods The analysis make use of various instruments at the time of financial analysis. Among these instruments, ratio analysis is the first in the priority list. Trend analysis , cross section analysis and common size statements are also most widely used methods. Using the financial statement the Lending Officers must assess the repayment capacity of a business to meet its loan and identify the source of repayment. The Lending Officer must also have done a ratio analysis in order to assess the customer ability to repay his/her/its debt; 10/18/2023 92

93. Cont… Analyze and interpret the cash-flow and the financial ratios from the historical financial accounts of the business using Siinqee Bank’s Financial Analysis Spreadsheet. The spread sheet should be filed properly with maximum care and should be attached with the report to be produced. 10/18/2023 93

94. Ratio Analysis Ratios are the main tools of financial analysis. There are an endless number of ratios that could be established between the figures in a set of financial statements. The Credit performer must also compare each ratio from the previous periods. The reason for any major changes from one period to another must be ascertained through discussion with the customer. 10/18/2023 94

95. Cont… It is well known that, normally ratios provide us with a way to express the relationship between figures and are useful tool of analyzing. In practice, there is no “correct or perfect ratio” for any particular business in ratio analysis. Still, there are two instruments useful in deriving meaningful information from ratios. These are: - Comparison against industry average ( vertical analysis); Trend in ratio over time ( horizontal analysis ). 10/18/2023 95

96. Cont.. In practice, horizontal analysis involves comparison of ratio of the same company over time in order to identify trends. Whereas vertical analysis is comparing ratios of a particular company with the industry average, average of similar companies in the industry, etc. Ratios are warning signals, which assist in identifying areas that need further investigation. Valid conclusions as to cause and effect of changes could only be made after obtaining further information. 10/18/2023 96

97. Common Problem observed of Ratios: Ratios do have a number of failings and the lists below are few among many. Analysis tend to rely too much on figures produced, but the figures are only as good as the information in financial statements; Balance sheet is a one moment in time picture; Seasonal nature of some business; Cyclical nature of the business; and Accounting policy (asset valuation) etc It is worthwhile to note that the final three points are very important particularly when undertaking a vertical analysis. 10/18/2023 97

98. Classification of ratios Ratios can be classified in to three major types: - Static Ratio: - these are ratio that compare one balance sheet figure against another, e.g. current ratio; Dynamic ratio : - These are ratio, which compare one figure from the profit and loss accounts with another in the same statement, e.g. profit margin; Hybrid Ratio : - this compares balance sheet figure to income statement figure or vice versa. However, these ratios will be distorted as they compare a one – moment figure with a figure representing a full year total. Therefore, extreme care should be taken with the interpretation of hybrid ratios. 10/18/2023 98

99. Types of Ratios The most widely used ratios included activity ratios, Leverage ratios or capital structure ratios, coverage ratios, liquidity ratios and Profitability ratios. 10/18/2023 99

100. Activity Ratios The finances obtained by a firm from its owners and creditors will be invested in assets. These assets are used by the firm to generate sales and profits. The amount of sales generated and the obtaining of the profits depend on the efficient management of these assets by the firm. Activity ratios indicate the efficiency with which the firm manages and used its assets . That is why these activity ratios are also known as ‘efficiency ratios’. They are also called ‘ turnover ratios’ because they indicate the speed with which assets are being converted or turned over into sales. Thus, the activity or turnover ratio measures the relationship between sales on one side and various assets on the other. 10/18/2023 100

101. Cont… The underlying assumption here is that there exists an appropriate balance between sales and different assets . A proper balance between sales and different assets generally indicates the efficient management and use of the assets. Many activity ratios can be calculated to know the efficiency of asset utilization. In addition, the ratio refers to the sales activity of the business. The ratio reflects the increase or decrease in sales levels for the business from one period to another. 10/18/2023 101

102. Cont… Activity Ratio = Sales Current Period – Sales previous Period Sales Previous Period The Lending Officer should note that changes in sales levels are made up of two basic components: price and volume . The breakdown of sales (i.e. price and volume) will not be evident from the financial accounts and must be ascertained through discussion with the customer. 10/18/2023 102

103. Cont… The following are some of the important activity ratios or turnover ratios: Total Assets Turnover Ratio This ratio measures the overall performance and efficiency of the business enterprise. It points out the extent of efficiency in the use of assets by the firm. This ratio is calculated by dividing the annual sales value by the value of total assets . Normally, the value of sales should be considered to be twice that of the assets. 10/18/2023 103

104. Cont… A lower ratio than this indicates that: - The assets are lying idle; While a higher ratio may mean that there is overtrading. Sometimes, intangible assets (goodwill, patents, etc) are excluded from the total assets and the total tangible assets-turnover ratio is calculated. For calculating this ratio fictitious assets (P & L A/c debit balance, deferred expenditure, etc) should be ignored. 10/18/2023 104

105. Capital Employed Turnover This is also known as ‘Sales-Net worth Ratio’. The capital employed is equal to the non-current liabilities plus the owners’ equity. This represents the permanent capital or long term funds entrusted to the firm for use by the owners and creditors. The capital employed can be treated as equivalent to the net working capital plus the non-current assets. This ratio examines the effectiveness in utilizing the capital employed. 10/18/2023 105

106. Cont… It is calculated by dividing the sales value by the capital employed . Thus the ratio indicates the firm’s ability to generate sales per unit of the capital employed (long term funds). The higher the ratio, the more efficient the utilization of the owners’ and the long term creditors’ funds. The efficiency of the operations of a firm need not be ascertained solely on the basis of this ratio. Other ratios which are related to it also should be considered. 10/18/2023 106

107. Cont… Fixed Assets – Turnover Ratio This ratio measures the firm’s efficiency in utilizing its fixed assets. Firms which have large investments in fixed assets usually consider this ratio; It indicates the extent of capacity utilization in the firm. The ratio is calculated by dividing the total value of sales by the amount of fixed assets invested . A high ratio is an indicator of overtrading while a low ratio suggests idle capacity or excessive investment in fixed assets. Normally, a ratio of five times is taken as a standard. 10/18/2023 107

108. Cont… Current Assets Turnover This ratio is calculated by dividing the net sales value by that of the current assets . It indicates the contribution of current assets to the sales. 10/18/2023 108

109. Cont… Working Capital Turnover This ratio indicates the efficiency of the employment of working capital. If supplemented with the net worth turnover ratio, it indicates the under capitalization of the overtrading of the concern. A firm is said to be undercapitalized if its return on capital is unusually high when compared to similarly situated firms. This ratio is calculated by dividing the net sales value by the net working capital . There is no standard norm for this ratio. It can only be stated that the firm should have adequate and appropriate working capital to justify the sales generated. 10/18/2023 109

110. Cont… Stock Turnover or Inventory Turnover This ratio indicates the efficiency of the firm’s inventory management. It is calculated by dividing the Cost of Goods Sold by the average inventory. Stock Turnover = Cost of goods sold Average Stock Cost of goods sold = Sales – Gross Profit or Opening Stock + Purchases + Mfg. Costs – Closing Stock. Average Stock = (Opening Stock + Closing Stock) 2. 10/18/2023 110

111. Cont… This ratio indicates the rapidity with which the stock is turning into receivables through sales. Generally, a high inventory turnover is an index of good inventory management and a low inventory turnover indicates an inefficient inventory management. Low stock turnover implies the maintenance of excessive stocks which are not warranted by production and sales activities. It also may be taken as an indication of slow moving or non-moving and obsolete inventory. A too high inventory turnover also is not good. It may be the result of a very low level of stocks which may result in frequent stock-outs. The stock turnover should be neither too high nor too low. 10/18/2023 111

112. Cont… Debtors Turnover Credit sales are not an uncommon feature. When the firm sells goods on credit, book debts (receivables) are created. Debtors are expected to be converted into cash over a short period and hence are included in current assets. To a great extent the quality of debtors determines the liquidity position of the firm. The quality of debtors can be judged on the basis of debtors’ turnover and average collection period. Receivable turnover is calculated by dividing credit sales by average receivables: - 10/18/2023 112

113. Cont… Receivables turnover = Credit Sales Average Receivables This ratio indicates the number of times on an average the debtors or receivables turnover. The higher the value of debtors’ turnover, the more efficient is the management of assets. 10/18/2023 113

114. Cont… If the information about credit sales opening and closing balances of receivables is not available in the financial statements, the receivables turnover can be calculated by taking the total sales and closing balance of receivables Debtors Turnover = Total credit Sales Receivables 10/18/2023 114

115. Cont… Average Collection Period As stated earlier the average collection period ratio is another device for indicating the quality of receivables. This ratio shows the nature of the firm’s credit policy also. The average collection period is calculated by dividing days (or months) in a year by the receivables’ turnover. Average Collection Period = Days in a year/12 months Receivables’ Turnover The average collection period and the receivables’ turnover are interrelated. The receivables turnover can be calculated by dividing days in the yare by the average collection period. 10/18/2023 115

116. Cont… Inventory Turnover (in days) or Number of days in Inventory It indicates how long the company carries its inventories in warehouse on the average. It is calculated using the following formula: - Number of days in Inventory = Average Inventory X 360 Cost of goods sold In the formula inventory is compared to cost of goods sold, not to sales, because sales includes profit margin. 10/18/2023 116

117. Cont… Quick inventory turnover can indicate: - Higher demand for commodity; Seasonal movements; Insufficient purchase; Changed production methods (contract out); Fall in price of raw materials; Methods of inventory valuation used; Shortage or difficulty in obtaining supplies (raw material: 10/18/2023 117

118. Cont… Slow inventory turnover indicates one or more of the following: - Difficulty in selling; Seasonal movement; Speculative buying; Inventory obsolescence; Over – buying in relation to need of the business; Deterioration of some inventory; Production not matching to falling sales; Raw material price increase etc 10/18/2023 118

119. Cont… Possible distortion include: - The ratio indicates for the whole inventory but different line of products may have different periods; Method of pricing for closing inventory and cost of goods sold could differ and it can distort the ratio if the method is changed; If inventory and payables (creditors) are large, it could indicate recent purchase. Given the above stated points interpretation of inventory turnover both too small below the industry average and too high above the industry average should be cautiously observed. 10/18/2023 119

120. Cont… Average Collection period (in days) Average Collection Period = Average AR X 360 Net Credit Sales The ratio shows the company’s internal collection efficiency of its receivables provided that, sales are evenly spread throughout the year. The speed at which debts are collected is an important indicator of liquidity. The result shows the number of days receivables remain outstanding. 10/18/2023 120

121. Cont… Credit Taken (In days) This ratio shows how fast or slow a company pays its debts. It indicates the number of days a company takes to settle its trade creditors. It is calculated using the following formula: - Creditors day = Average trade creditors X 360 Credit purchase This ratio gives company’s reliance on creditors to fund operations, if purchase is evenly spread throughout the year. 10/18/2023 121

122. Cont… Increase in number of creditors’ days may indicate: More reliance on creditors for financing company operation; Company is strong that is can dictate its own terms; Company is short of cash and cannot afford to pay its creditors etc Decrease in number of creditors’ days indicates: - Creditors are refusing to allow trade credit or they are pressing for payment; Company is failing to take advantage of available credit terms; Taking advantage of discounts for early payment. 10/18/2023 122

123. Cont… Profitability Ratios Profitability means the ability to make profits. Profitability ratios are calculated to measure the profitability of the firm and its operating efficiency. They relate profits earned by a firm to different parameters like sales, capital employed and net worth . From the management point of view, profitability ratios are calculated for measuring the efficiency of operations. There are two types of profitability ratios calculated for this purpose. They are: 1. Profitability in relation to sales, and 2. Profitability in relation to investment. 10/18/2023 123

124. Cont… Every firm should generate sufficient profit on each Birr of sales otherwise it would be very difficult for the firm to recover operating expenses and non-operating expenses like interest charges. Similarly, if the firm’s earnings are not adequate in terms of its investment in assets and in terms of capital employed (contributions by owners and creditors) its very survival will be at stake. 10/18/2023 124

125. Cont… Profitability in relation to sales Under this category many profitability ratios are calculated relating different concepts of profit to the sales value. Some such ratios are:   Gross Profit margin or Gross Profit to Sales This ratio is calculated by dividing gross profit by sales value. Gross profit margin = Gross Profit = Sales – Cost of goods sold Sales   10/18/2023 125

126. Cont… In a steady situation, this ratio is expected to remain stable irrespective of the level of production or sales. If there is change in gross profit margin, the analyst has to investigate further to identify the cause. As mentioned above, a steady and adequate rate of Gross Profit is the most reliable evidence of efficient management. The ratio indicates the efficiency of operations and firm pricing policies 10/18/2023 126

127. Cont… The following can cause declining Gross Profit. Lack of stocking; Incorrect stock valuation; Competence of management – pilfering by employees, bad buying etc; Poor quality control – goods being returned High cost of goods sold.   10/18/2023 127

128. Cont… Gross Operating Margin This ratio is calculated by dividing gross operating margin by sales. Gross operating margin = Gross profit minus operating expenses except depreciation. This ratio indicates the extent to which the selling price per unit may decline without incurring any loss in the business operations. It is rather difficult to evolve a standard norm for this ratio. But it should not be lower than that of similar concerns. 10/18/2023 128

129. Cont… Net Operating Margin This ratio is calculated by dividing the net operating profit by (net) sales. The net operating margin may be calculated as follows: Net Operating Margin = Gross Operating margin – DepreciationX100 Sales For this ratio no standard norm is evolved. The ratio of a firm may be compared with that of sister concerns to measure the relative position. 10/18/2023 129

130. Cont… Net Profit Margins or Net Profit to Sales This is one of the very important ratios and measures the profitableness of sales. It is calculated by dividing the net profit by sales . The Net profit is obtained by subtracting operating expenses and income tax from the gross profit. Generally, non-operating incomes and expenses are excluded for calculating this ratio. This ratio measures the ability of the firm to turn each Birr of sales into net profit. It also indicates the firm’s capacity to withstand adverse economic conditions. A high net profit margin is a welcome feature to a firm and it enables the firm to accelerate its profit at a faster rate than a firm with a low net profit margin. 10/18/2023 130

131. Cont… In order to have a more meaningful interpretation of the profitability of a firm, both gross margin and net margin should jointly be evaluated. If the gross margin has been on the increase without a corresponding increase in net margin, it indicates that the operating expenses relating to sales have been increasing. The analyst should further analyze in order to find out the expenses which are increasing. The net profit margin can remain constant or increase with a fall in gross margin only if the operating expenses decrease sufficiently. 10/18/2023 131

132. Cont… As that of Gross Profit, net profit margin is a measure of profitability except it is computed after deducting expenses. This ratio could be computed from two figures, profit before or after tax. Net Profit Margin = NIBT x 100 Sales Or Net Profit Margin = NIAT X 100 Sales 10/18/2023 132

133. Cont… It is important to note that deterioration in this ratio may be caused, among other things, by the factors listed below: Decreased Gross Profit; Increase in cost and expense As a normal practice, profit margins should be analyzed vertically in evaluating Generally, it indicates the firm’s profitability after taking account of all expenses and income taxes. 10/18/2023 133

134. Cont… Operating Ratio The ratio is an index of the operating efficiency of the firm. It explains the changes in the net profit margin. This ratio is calculated by dividing all operating expenses (i.e., cost of goods sold plus administration and selling expenses) by sales . Operating ratio = Cost of goods sold + Operating Expense Sales This ratio is also expressed as a percentage. 10/18/2023 134

135. Cont… Profitability in Relation to Investment Profitability of a firm can also be measured in terms of the investment made. The term, ‘investment’, may refer to total assets, total operation assets, capital employed or the owners’ equity. Accordingly, many profitability ratios in relation to investment can be calculated. The important ratios are discussed here under: 10/18/2023 135

136. Cont… Return on assets This ratio is calculated by dividing net profit after tax by total assets: Return on assets (ROA ) = Net Profit after tax Total assets   There are many variations on the return on assets ratio mix depending on the particular concept of net profit and assets used. The different concepts of net profit used include net profit after tax , net profit after tax plus interest (on loans), net operating profit, and net profit after taxes plus interests minus tax savings. Similarly, the concept ‘assets’ may indicate total assets, fixed assets, tangible assets, operating assets, etc. 10/18/2023 136

137. Cont…. The different variants of the Return on assets may be as under: Return on Assets = Net Profit after tax Total assets = Net Profit after tax + interest Total assets = Net Profit after tax + interest Tangible assets = Net Profit after tax + interest Fixed assets = Operating Profit Operating assets 10/18/2023 137

138. Cont… Operating assets are the assets which are used in the regular conduct of the business operations. They include mostly tangible fixed assets and current assets. Investments are generally excluded when calculating the operating assets. This Return on Assets ratio measures the profitability of the total assets (or investment) of a firm. But this ratio does not throw any light on the profitability of the different sources of funds which have financed the total assets. This aspect of profitability is covered by Return on capital employed. 10/18/2023 138

139. Cont… Return on Capital Employed This is a similar to ROA except that in this ratio profits are related to the capital employed. The term, ‘capital’, employed refers to the long-term funds supplied by creditors and owners of the firm. This ratio indicates how efficiently the management of the firm has used the funds supplied by creditors and owners. The Capital Employed can be ascertained in two ways by taking the non-current liabilities plus owners’ equity or by considering the net working capital plus net fixed assets. The higher the ratio ROCE, the more efficient has been the use of capital (long term funds) employed. The Return on capital employed (ROCE) can be calculated by using different concepts of profit and capital employed. 10/18/2023 139

140. Cont… ROCE = Net Profit after Tax Total Capital Employed Or = Net Profit after Tax Total Capital Employed  = Net Profit after Tax Total Capital Employed 10/18/2023 140

141. Cont… Short-term Liquidity Ratios Short – term liquidity is measured or assessed by comparing current asset against its counterpart liability. There are two most commonly used ratios discussed next. Current Ratio It measures the margin of safety for paying current debts as they fall due. It is an indicative of the short – term solvency of the company. current ratio (%) = Current Assets X 100 Current Liability 10/18/2023 141

142. Cont… Trends of current ratio are different to analyze and probably could mislead. An increase may reflect an increase solvency – positive. In the contrary, high level not saleable stock or overdue receivable, which are hardly collectible may give higher current ratio but negative. Likewise, decrease in current ratio may emanate from greater efficiency or actual worsening liquidity – real problem. Therefore, when interpreting this ratio , the following points should be taken in to account: - 10/18/2023 142

143. Cont… This ratio requires qualitative analysis (especially for stock and debtors); It is dependent upon classification of assets into current and long term that could be biased and doubtful; It could be affected by accelerated year – end transaction creating room for manipulation; It is dependent upon, quality of assets, their composition and nature of the business; Asset concision cycle should be taken in to account. 10/18/2023 143

144. Cont… Quick Ratio It shows the ability of a company to meet its current obligations using funds from quick assets. Quick ratio = Cash + short term inv. + Debtors X 100 Current Liability   It gives more stringent/strict test of short – term liquidity 10/18/2023 144

145. Cont… Financial Leverage Ratios Successful use of debt enhances earnings for the owners of the business, because the returns earned on these funds—over and above the interest paid—belong to the owners, and thus will increase the return on owners’ equity. From the lender’s viewpoint, however, when earnings do not exceed or even fall short of the interest cost, fixed interest and principal commitments must still be met. The owners must fulfil these claims, which might severely affect the value of owners’ equity. The positive and negative effects of leverage increase with the proportion of debt in a business. With higher leverage, the risk exposure of the providers of debt grows, as does the risk exposure of the owners. 10/18/2023 145

146. Cont… Debt to Assets The first and broadest test is the proportion of total debt, both current and long- term, to total assets, which is calculated as follows: Total Debt= Total Debt Total Asset This ratio describes the proportion of “other people’s money” to the total claims against the assets of the business. The higher the ratio, the greater the risk for the lender. This is not necessarily a true test of the ability of the business to cover its debts, however. 10/18/2023 146

147. Cont…. Debt to Capitalization A more refined version of the debt proportion analysis involves the ratio of long- term debt to capitalization (total invested capital/Capital employed). when the current portion of long-term debt, long-term liabilities, and deferred taxes are included in the debt total: 10/18/2023 147

148. Cont… Debt to capitalization= Long term Debt Capitalization (Net Asset )   The ratio is one of the elements that rating companies such as Moody’s take into account when classifying the relative safety of debt. Another definition of debt is sometimes used, which includes short-term debt (other than trade credit), the current portion of long-term debt, and all long-term debt in the form of contractual obligations. 10/18/2023 148

149. Cont… Debt to Equity Debt to equity= Total Debt Shareholders’ Investment A third version of the analysis of debt proportions involves the ratio of total debt, frequently defined as the sum of current liabilities and all types of long-term debt, to total owners ’ equity, or shareholders’ investment. The debt to equity ratio is an attempt to show, in another format, the relative proportions of all lenders’ claims to ownership claims, and it is used as a measure of debt exposure. The measure is expressed as either a percentage or as a proportion. 10/18/2023 149

150. Cont… Debt to equity (alternate) = Long-Term Debt Shareholders’ Investment (Equity) The various formats of these relationships imply the care with which the ground rules must be defined for any particular analysis, and for the covenants governing specific lending agreements. They only hint at the risk/reward trade-off implicit in the use of debt. 10/18/2023 150

151. Cont… Debt Service Regardless of the specific choice from among the several ratios debt proportion analysis is in essence static, and does not take into account the operating dynamics and economic values of the business. The analysis is totally derived from the balance sheet, which in itself is a static snapshot of the financial condition of the business at a single point in time. company’s ability to pay both interest and principal on schedule as contractually agreed; 10/18/2023 151

152. Cont… Interest Coverage One very frequently encountered ratio reflecting a company’s debt service uses the relationship of net profit (earnings) before interest and taxes (EBIT) to the amount of the interest payments for the period. This ratio is developed with the expectation that annual operating earnings can be considered the basic source of funds for debt service, and that any significant change in this relationship might signal difficulties. Major earnings fluctuations are one type of risk considered. 10/18/2023 152

153. Cont… Interest coverage= Net profit before interest and taxes (EBIT) Interest   Burden Coverage A somewhat more refined analysis of debt coverage relates the net profit of the business, before interest and taxes, to the sum of current interest and principal repayments, in an attempt to indicate the company’s ability to service the burden of its debt in all aspects. 10/18/2023 153

154. Cont… One correction often used involves converting the principal repayments into an equivalent pre-tax amount. This is done by dividing the principal repayment by the factor “one minus the effective tax rate.” Burden coverage = Net Profit before interest and taxes (EBIT) Interest + Principal Repayments/ (1-Tax rate)] 10/18/2023 154

155. Statement of Cash Flow Introduction A financial statement that shows how change in balance sheet account and income affects cash and cash equivalents, and breaks the analysis down to Operating, Investing and financing activities; Concerns with the flow of cash in and out of the business; determine the short-term viability of company , particularly its ability to pay bills, 10/18/2023 155

156. Cont… The cash flow statement reflects a firm's liquidity. The balance sheet is a snapshot of a firm's financial resources and obligations at a single point in time, and the income statement summarizes a firm's financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues. 10/18/2023 156

157. Cont… The cash flow statement includes only i nflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These non-cash transactions include depreciation or write-offs on bad debts or credit losses to name a few. The cash flow statement is a cash basis report on three types of financial activities: operating activities, investing activities, and financing activities. The cash flow statement is thus intended to; 10/18/2023 157

158. Cont… provide information on a firm's liquidity and solvency and its ability to change cash flows in future circumstances; provide additional information for evaluating changes in assets, liabilities and equity; improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods ; indicate the amount, timing and probability of future cash flows; 10/18/2023 158

159. Cont… Parts of Cash flow statement As briefly discussed above, the cash flow statement is partitioned into three segments namely: Cash flow resulting from operating activities Cash flow resulting from investing activities and Cash flow resulting from financing activities. 10/18/2023 159

160. Cont… Operating activities Operating activities include the production , sales and delivery of the company's product as well as collecting payment from its customers. This could include purchasing raw materials, building inventory, advertising and shipping the product. Operating cash flow includes: 10/18/2023 160

161. Cont… Receipts from the sale of goods or services; Receipts for the sale of loans, debt or equity instruments in a trading portfolio; Interest received on loans; Payments to suppliers for goods and services; Payments to employees or on behalf of employees; Interest payments; buying merchandise; Others 10/18/2023 161

162. Cont… Investing activities Purchase or sale of an asset (assets can be land, building, equipment, marketable securities, etc.) Loans made to suppliers or received from customers; Payments related to mergers and acquisition; Proceeds from issuing short-term or long-term debt; Repayment of debt principal, including capital leases; 10/18/2023 162

163. Cont… Financing activities Financing activities include the inflow of cash from investors such as banks and shareholders , as well as the outflow of cash to shareholders as dividends as the company generates income. Other activities which impact the long-term liabilities and equity of the business are also listed in the financing activities section of the cash flow statement. 10/18/2023 163

164. Cont… Methods of Preparing Cash flow Statement Basically, there are two ways to prepare cash flow statement namely the direct and indirect method. The direct method of preparing a cash flow statement results in a more easily understood report. The indirect method is almost universally used. 10/18/2023 164

165. Direct method The direct method for creating a cash flow statement reports major classes of gross cash receipts and payments. If taxes paid are directly linked to operating activities, they are reported under operating activities; if the taxes are directly linked to investing activities or financing activities, they are reported under investing or financing activities. 10/18/2023 165

166. Indirect method The indirect method uses Net-Income as a starting point, makes adjustments for all transactions for non-cash items, then adjusts from all cash-based transactions. An increase in an asset account is subtracted from net income, and an increase in a liability account is added back to net income. This method converts accrual-basis net income (or loss) into cash flow by using a series of additions and deductions. 10/18/2023 166

167. Cont… Rules (operating activities) The following rules can be followed to calculate cash flows from operating activities when given only a two-year comparative balance sheet and the net income figure. Cash flows from operating activities can be found by adjusting Net Income relative to the change in beginning and ending balances of current assets, current liabilities, and sometimes long term assets. When comparing the change in long term assets over a year, the accountant must be certain that these changes were caused entirely by their devaluation rather than purchases or sales (i.e. they must be operating items not providing or using cash) or if they are non-operating items. 10/18/2023 167

168. Cont… Decrease in non-cash current assets are added to net income Increase in non-cash current asset are subtracted from net income Increase in current liabilities are added to net income Decrease in current liabilities are subtracted from net income Expenses with no cash outflows are added back to net income (depreciation and/or amortization expense are the only operating items that have no effect on cash flows in the period) Revenues with no cash inflows are subtracted from net income Non operating losses are added back to net income Non operating gains are subtracted from net income 10/18/2023 168

169. Cont… Sources of Cash Cash sales – Debtor payments; Increase in borrowings or overdraft (Bank or other); Usage of funds on current or saving accounts generated in previous periods; Sale of fixed assets; Investment in the business by directors or others; Reduction in working capital; 10/18/2023 169

170. Cont… Cash sales/debtor payments Sales would be regarded as the primary source of funds to a business. The main purpose of a business is to generate sales at a sufficient level to fund all of their costs and provide an adequate return to the owners or shareholders. Given a preference the management would sell only on cash terms, as this eliminates the possibility of bad debts and the timing differences that arise while awaiting payment from debtors. However if the nature of the business or the competition demands that credit terms are given, then the cash inflow from sales will only occur when payment is received from debtors. 10/18/2023 170

171. Cont… Increase in borrowings or overdraft Banks and other lenders are a secondary source of funding to a business. The funding provided from these sources is temporary as any advances must be repaid in accordance with the agreed terms of repayment. Overdraft finance for example can fund the short term timing gaps that arise between sales and receipt of payments from debtors. If the overdraft is not repaid in the short term, then difficulties will arise when the company next needs to finance a short term timing gap in cash-flow 10/18/2023 171

172. Cont… Medium and long term loans will provide immediate funding to purchase fixed assets and enable the business to make repayments over a number of periods, and thus reduce the immediate demands on the cash-flow of the business. However if bank borrowings are continually used to finance shortages in the business cash flow, this will create difficulties when the Bank refuses to extend additional credit and demands repayment of past loans. 10/18/2023 172

173. Cont… Usage of funds generated in previous periods If a business has generated more funds in previous periods than it has used, the additional funds will generally be reflected in credit balances on bank current account or deposit. These funds will be available in subsequent periods if cash-flow is not sufficient to meet all requirements. 10/18/2023 173

174. Cont.. Sale of fixed assets Obviously a business will not resort to selling its core fixed assets to prop up temporary cash shortages; However, if replacement assets are required and the assets being replaced have a disposal value, then the business can fund part of the new capital expenditure from the sale proceeds of the surplus assets; 10/18/2023 174

175. Cont… Investment by directors or others Basically, when a business is unable to generate sufficient funds to meet requirements, the additional funding required should be applied either temporally or permanently by the owners of the business; This is a far safer source of funding than borrowing from banks, as the repayment terms (if required) can be geared to the cash generation ability of the business; The funding might be introduced in the form of permanent capital to the business. Unfortunately most directors are either unwilling or unable to provide funding to their businesses when called upon to do so; 10/18/2023 175

176. Cont… Decrease in stock Stock is an asset that a majority of businesses are required to carry to meet the needs of their customers. Although designated as a current asset, it is not true to say that it is a temporary requirement within a business. Generally, stock will turn over regularly in line with the sales pattern of the business. However all business have a core level of stock that must be carried permanently. When sales reduce stock levels to below that of the core value, replacement stock is purchased to keep the stock at a level sufficiently high enough to match customer demand. 10/18/2023 176

177. Cont… Decrease in debtors Debtors are another asset being carried by a business through necessity. As explained above, debtors are a regular source of funding to a business when payments are received; However, similar to stock, there is a core level of debtors that must permanently be carried by the business; 10/18/2023 177

178. Cont… Timing differences between sales and payment result in further credit sales being made in the period between sales and payments from debtors. The longer that gap is, the higher the level of core debtors that the business will have to carry. Similarly to stock, as debtors are turned into cash on a regular basis, they are in turn being replaced by new debtors. If the business can reduce the time gap between sales and receipt of payment from debtors it will reduce the core level of debtors being carried. The funds being released by this reduction can be used elsewhere in the business. 10/18/2023 178

179. Cont… Increase in creditors A business must purchase its stock from its suppliers. If the business can obtain credit terms from suppliers, this creates a timing gap between purchase and payment. Similarly to the illustration on debtors above, as payment is made to creditors new goods are being purchased, keeping a core level of creditors that helps to fund the stock being carried by the business. The longer the business can delay making payment to creditors, the higher the funding provided from that source. However, there are limitations in extending credit terms beyond those agreed with suppliers. 10/18/2023 179

180. Cont… Uses of Cash Cash purchases – Creditor payments Loan repayments – Permanent reductions to overdrafts Payment of wages/salaries Payment of other expenses Payment of taxes Purchase of fixed assets Payment of dividends to director shareholders Increases in working capital. 10/18/2023 180

181. Cont… All businesses generally have high requirements for cash. Only a few businesses are in the fortunate position of regularly generating more cash than they can use. Cash is therefore, a scarce resource and must be managed carefully to ensure that there is a constant availability to fund the continuing operations of the business. Sources must be matched with uses to ensure that timing differences do not result in an inability to fund essential activities of the business. The sources and uses of cash is known as the cash cycle of the business and it is vital to the continued success of a business that it generates sufficient cash from its operating sources to meet operating uses including loan repayments. 10/18/2023 181

182. Summary Good credit management does not consider collateral to be a substitute for creditworthiness, which is the existence of cash flow adequate to repay the loan; Any proposed borrowing is closely related to both amount and payback. Hence, the performer should always assess how the additional borrowings requested will enhance the business; Will the borrowings generate additional funds or reduce existing overheads. (e.g. The purchase of new machinery may result in saving on repairs to obsolete machinery or may improve quality standards or increase production); 10/18/2023 182

183. Cont… Assessment of repayment capacity is at best a rough estimate of the ability of a business to meet loan repayments in the future. It is an inexact science and therefore margin must be allowed for unexpected contingencies. Accounts provided by customers are not always an accurate reflection of business operations and such that a performer needs to have a good knowledge of business and finance in order to extract sufficient information from the customer to make a reasonable assessment; These skills come from practise and it is generally possible to spot deficiencies in information; 10/18/2023 183

184. Cont… There might be instances when there is reduced operating cash-flow occurs. This may be as a result of: Reduced turnover (market/economic conditions – competition – customer demand) Increase in overheads (possibly poor cost control) Large financing charges (business over borrowed) Working capital management problem: High levels of stock Slow collection of Debtors/credit terms too generous to customers/ over reliance on a small number of customers who can dictate credit terms. 10/18/2023 184

185. WORKING CAPITAL DETERMINATION Meaning of Working Capital In financial management, two important investment decisions are vital. They are decisions regarding investment in fixed assets/fixed capital and working capital (current assets); Whereas working capital refers to funds locked up in current assets and liabilities such as inventory (raw materials, work-in-process and finished goods), supplies, receivables, cash, payables etc; 10/18/2023 185

186. Cont… Working capital is required for the smooth running of day to day operation of the business. Mismanagement of working capital will lead to failure of a business. Working capital is like blood circulation in our body. If there is no circulation of blood, we know we would almost be dead or if some clot in the blood happens in one part of the body, then that part becomes numb and not in a position to use; 10/18/2023 186

187. Classification of working capital Gross working capital It is simply called as working capital and it refers to the firm’s investment in current Assets. Current Assets represent: Cash, Short term securities, Debtors, Stocks, etc. 10/18/2023 187

188. Cont… Net Working Capital It refers to the difference between Current Assets and Current Liabilities.; That is equal to the value of raw materials, work in-progress, finished goods inventories and accounts receivable less accounts payable Current Assets refer to those assets which can be converted in to cash within the accounting year. Current Liabilities refers to those claims of outsiders which are expected to mature within the accounting year. 10/18/2023 188

189. Cont… Thus net working capital indicates the liquidity position of the firm and suggests the extent to which working capital needs may be financed by permanent sources of funds (i.e. going to be financed by owner’s capital, long term debt or retained earnings.) Working capital requirement of a firm can be classified into Permanent/Fixed/Regular working capital and Temporary/Fluctuating/Seasonal/variable Working capital. The distinction between permanent and temporary working capital attains importance because the source of funds for permanent WC should come from long-term sources while that for temporary WC from short-term sources ; 10/18/2023 189

190. Cont… Permanent WC The magnitude of current assets needed is not always same, it increase and decreases over time. The minimum level of current assets which is continuously required by the firm to carry on its business operations is referred as permanent, or fixed, working capital Variable WC The extra working capital needed to support the changing production and sales activities as well as for meeting seasonal requirements and execution of special orders are referred as fluctuating, or variable or temporary, working capital; 10/18/2023 190

191. Determinants of Working Capital Requirement Nature of business Size of business Manufacturing cycle Business fluctuation Production Policy Credit policy Growth and expansion activities Price level changes 10/18/2023 191

192. Determination of Working Capital Investment in current assets should be just adequate/accurate, not more nor less, to the needs of the business firm; Excessive and inadequate investment in current assets is dangerous for the business; Hence, it should be optimal. A firm should achieve balance between having sufficient working capital to ensure that the business is liquid but not too much that the level of working capital reduced its profitability; 10/18/2023 192

193. Operating Cycle Method There is no specific way in which current assets should be financed; In general Investment in current asset is realized during the firms operating cycle which is usually less than a year; Since working capital is represented by the sum of current assets, the investment in the same is determined by the level of each current asset item; The size of investment in each component of working capital is decided by the length of OC; 10/18/2023 193

194. Cont… The operating cycle of manufacturing company involves three phases. Acquisition of resources such as raw material, Labour, fuel, etc. Manufacture of the product which includes conversion of raw material in to work in progress in to finished goods Sales of products either for cash or on credit. Credit sales create books debts for collection. 10/18/2023 194

195. Cont… Determining Operating Cycle (Working Capital Cycle) How is the operating cycle determined? The length of operating cycle of manufacturing firm is the sum of: 1. Inventory conversion period (ICP or stock days) 2. receivables conversion period (RCP or Accounts Receivable/debtors days) minus the payable deferral period (PDP or Accounts Payable/creditor days). Inventory conversion period is the total time needed for producing and selling the product. Payable deferral period (PDP or Accounts Payable/creditor days) is the length of time the firm is able to defer payments on various resource purchases 10/18/2023 195

196. Cont… Inventory conversion period = Raw material conversion + Work in process conversion period + finished goods conversion period; The difference between the gross operating cycle and payables deferral period is net operating cycle. 10/18/2023 196

197. Description Formula* Information Required from customers CURRET ASSETS Stock of Raw Materials (a ) RM Days x Annual RM cost / working days in a year -minimum RM holding period Work-in-process (b WIP Days (annual RM cost + Annual DL cost+ Annual FOH) / working days in a year - Average production process time Stock of finished Goods (c) FG Days (Cost of finished Goods produced + general expenses (exclude depreciation and finance costs /Working days in a year) -holding period of finished goods in days Debtors (d) Credit sales X AR Days)/ Annual working days - credit policy (average debt collection period) Cash and Bank Balance (e) Minimum cash balance required to be maintained -minimum petty cash requirement Current Assets- TOTAL a+ b+ c+d+e Less: CURRENT LIABILITIES Trade Creditors (f) Annual Cost of Goods sold (purchase) X AP Days)/ Annual working days Accounts Payable Policy (average trade payable period) Current Liabilities- Total f Working Capital Requirement Per Cycle Current Assets – Current Liabilities 10/18/2023 197

198. Cont… Illustration of the length operating cycle Items……………………..Value…………….Total Raw material………………….68 Work in process………………23 Finished goods………………. 38 …….…………..129 Receivable Conversion period…………………… 50 Gross operating cycle…………………………….179 Payment deferral period…………………………(35) Net operating cycle…………….………………….144 10/18/2023 198

199. The Cost of Goods Sold Method Key Description A.    Forecasted Total sales B.    Average of Ratio of cost of Goods sold to net sales of at least for three years (in percentage) C.    Cost of Goods Sold (A*B) D.    Average working capital cycle ( as determined by industry) E.    Working capital requirement per one cycle (C/D) F.    Net current asset G Limit of the existing facilities like Overdraft , Pre-shipment H.    Net Working capital requirement for one cycle ( (E-(F+G)) 10/18/2023 199

200. Cont… There are three approaches to estimate the coming full year sales figures such as Forecasted sales: As product of the base year sale and growth rate computation approach Forecasted sale = Base year sale * (1+Growth rate of the sales) Forecasted sale: an amount of sales for which the working capital requirement is going to be determined; 10/18/2023 200

201. Cont… Base year sale The base year is the sales amount which used as a basis to forecast the next year sales; Growth rate: a rate at which the base year sales is augment to obtain the forecasted sale; Base year sale and growth rate are employed for the computation of the forecasted sale. These factors can be approached in different ways. The different options of approaching the factors are presented as follows: 10/18/2023 201

202. Cont… Base year Sale computation Base year sale can be computed in various ways depending on the nature of the business, trend of financial condition and external factors affecting the business. The common approaches of calculating base year’s sales are the following: Taking an average of the latest three preceding years actual sales figure, Disregard exceptional minimum and/or maximum sales figures and compute the average sales figure, If the sales performance is consistent, the performer can take the latest full year sales performance as the base year figure, If there is any strong justification for the proxy of base year sale, the performer can use any alternative approach for calculation of the base year sale other than the above three approaches, 10/18/2023 202

203. Cont… Growth rate The forecasted sale is computed by projecting the base year sale by the possible growth rate. The rate of growth can be approached in the following alternatives: Average of at least the preceding three years sales growth rate; Disregard exceptional minimum and/or maximum sales growth rate and compute the average growth rate; If there is any strong justification the performer can use any other sales growth rate other than the above approaches ; 10/18/2023 203

204. Cont… Average Margin Of Cost Of Goods Sold To calculate the average margin of cost of goods sold, one of the following options shall be considered: Average of at least the previous three years cost of goods sold margin, Disregard exceptional minimum and /or maximum cost of goods sold margin and calculate the average based on the remaining year cost of goods sold margin, If the cost of goods sold margin is consistent, the performer could take the latest full year cost of goods sold margin, if there is any strong justification the performer can use any alternative method for computing cost of goods sold margin other than the above three approaches . 10/18/2023 204

205. Cont… Net current asset Calculate the balance of net current asset by summing the stock , Trade debtors and deduct the trade creditors from the summed value; The latest balance of net current asset; Long outstanding debtors; Dead or obsolete stocks and others; 10/18/2023 205

206. Cont…. Sector Recommended turnover Export-Coffee average 2.5 times Export-Others average 3 times Manufacturing- Leather 1.5 times Manufacturing- Steel 2 times Manufacturing-Others average 2.5 times Import Average 3 times DTS Average 4 times 10/18/2023 206

207. Working capital requirement per birr of sale Steps of calculating the working capital 1. Calculate the forecasted sale 2. Compute the working capital requirement based on the working capital requirement per Birr of sale, say if it is 0.30, the working capital need to generate one Birr of sale is 30 cents. 3. In this computation, we get the overall working capital requirement for the total forecasted sale, so first we need to compute the working capital requirement per single cycle by dividing the yearly working capital by the number of turnover. 10/18/2023 207

208. Cont…. Working capital requirement per birr of sale Description A    Forecasted Total sales B    Average/computed working capital required per one birr of sale C    Working Capital Requirement Per Cycle(A*B) D   Net current asset E Total Bank financing required (=C-D) F Existing facilities limit G    Additional Bank finance required (E-F) 10/18/2023 208

209. LC Facility Limit Determination Step 1: Compute the import figure from the total actual Cost of Goods Sold Determine annual import figure based on the average growth rate of actual import figure ( at least three years data) from the total cost of goods sold. Step 2: Considering working capital cycle For simplicity purpose assumes there are three working capital cycle in a year. However, depending on the nature of the import (bulk import, country of shipment of imported goods and other based on previous year experience), the performer may change the working capital cycle. Step 3: Deduct the margin to be paid by the customer (i.e. customer’s equity) from the additional working capital Step 4: Determine Import facility Limit Deduct the existing L/C facilities with our bank and other banks while determining the working capital need. 10/18/2023 209

210. Summary for import L/C Description A Total yearly import purchases ( forecasted based on trend) B. No. of working capital cycles C Working capital requirement per one cycle (A/B) E Margin to be paid by the customer E Existing Facility Limit F. Net Working capital requirement for one cycle (C-D-E) 10/18/2023 210

211. For Applicants Who Have No Experience in Import Business For applicants who have no experience in the import business, the performer should set the working capital need/L/C facility limit based on the nature of the business, its production capacity and likely volume of import, financial strength of the customer, marketability of imported item, its importance to the country, the business plan of the customer and other issues related to the case. 10/18/2023 211

212. Pre-shipment Export Credit Facility Limit determination ( for new) Step 1: Set achievable export sales limit Assume the maximum export sales of the planned year as USD 300,000 or equivalent of other currencies. However, if the customer justifies its ability to export more than 300,000 USD , the customer’s plan could be considered. The ability of the customer shall be critically assessed in terms of availability of adequate logistics- raw material availability, processing machineries, storage facilities etc. 10/18/2023 212

213. Cont… Step 2 - considering working capital cycle Refer the points mentioned in Step 4 of the Cost of Goods Sold Method above regarding working capital cycles/turnover. Step 3- Set the limit of the pre-shipment facility The facility’s limit shall be set by dividing the total annual estimated export sales by the number of working capital cycles; 10/18/2023 213

214. Cont… Summary of the steps: Description A. Forecasted export sales B. No. of working capital cycles C. Export sales in one cycle (the facility’s limit to be set) (=A/B) 10/18/2023 214

215. NON-FINANCIAL ANALYSIS Scope & Methods of Non-Financial Analysis As financial assessment is very critical in credit analysis, assessment of Non-Financial issues of any applicant is very essential part of analysis and for better decision making as well; Considering the Non-Financial aspects of the applicant is mainly depends on the willingness of the applicant to provide the data, availability of specific type of non-financial data , the general knowledge of the business sector that the customer is engaged in and to the extent that we as credit performer value non-financial aspect; 10/18/2023 215

216. Cont… Assessment tools for non-financial analysis: SWOT Business plan analysis 5 C’s PESTEL Market Analysis(Porter’s Five forces Models, Competitor analysis) Industry Analysis Production Analysis Product analysis 10/18/2023 216

217. Risk Analysis Management risk Management quality and competence are measured in terms management’s ability to administer a business or a project effectively and efficiently, the strength of the management in finical administration, proper management the business, their relation with the labour and other management related issues. Deterioration of business may arise due to poor management quality, which makes going concern of the business to be questionable. High turnover of management and adverse relation with labour are also indicators of management risk, 10/18/2023 217

218. Cont… Business risk It refers to the extent of the business’s exposure to operational risk. It is examined in terms of Business/industry outlook Market competition/market share, business plan, life of business, sales trend, variance in net income before tax(NIBT) and net profit, sales/ total sales, NIBT/sales inventory turnover, ROA, ROE and earnings before interest and tax; 10/18/2023 218

219. Cont… Collateral risk This risk is identified by measuring the strength of the collateral backing the loan, marketability, extent of depreciation, traceability in the case of default, incompleteness and genuineness of the document. 10/18/2023 219

220. Thank you 10/18/2023 220