TOOL E4
This tool provides an overview of the four major components of financial risk analysis that together determine the financial performance of a company. It also describes the major financial ratios categories and the main questions to ask in order to focus on the key drivers of financial performance.
Debt Service Capacity & Liquidity
Objectives: To assess the quality of a client’s operating cash flows; the ability of the client to meet all business-related and financial charges from ongoing cash flows; and the ability to tap alternate sources of internal and external sources of funds to meet all current and contingent obligations when they become due.
Debt Service Capacity:
• What is the trend, volatility, and sustainability of operating cash flow?
• How does the debt maturity profile and funding structure impact on financial cash commitments?
• Is the client able to cover all financial charges (interest, principal, dividends) from operating cash flow (after CAPEX)?
Liquidity: What is the client’s ability to meet its business and financial obligations from alternate internal and external sources of liquidity
Revenues & Profitability
Objectives: To asses a client’s ability to generate profits, which ultimately drive cash flow.
Sales: How large is the client relative to others in the industry? What drives sales growth or decline?
Performance: Does the business add value from what it does? Is it affected by currency rates?
Expense management: What is the relationship between key expenses relative to sales?
Financial management: Is the business sufficiently profitable relative to its funding structure?
Profit taken by third parties: Are retained earnings building up the capital base sufficiently?
Asset Management
Objectives: To assess whether assets are being used efficiently to optimise profits (and ultimately cash flow) in the business.
Asset Conversion Cycle (“ACC”): How efficient does the client manage working capital, and how does it impact on margins and cash flow?
Fixed Assets (Tangible & Intangible): Are tangible fixed assets being used efficiently and are they being replaced / maintained adequately? Are intangible assets adding value to the business (i.e. operating margin)?
Financial Assets: Are financial assets (including investments in other businesses; joint ventures) generating an adequate return?
Leverage & Debt Service
Objectives: To assess the client’s usage of – and reliance on – external funding, and its capacity to raise and support debt on a sustainable basis.
Leverage: Is the funding structure appropriate and supportive relative to the business risks of the client? To what extent is the client reliant or over-reliant on external and possibly unstable sources of funds (including off balance sheet)? What is the quality of the clients’ assets: do they generate adequate levels of cash flow or have a value independent of the client in the stress scenario? Are there maturity and/or currency mismatches between assets and liabilities?
Debt Capacity: What is the client’s overall level of funded debt that can be comfortable supported on current and future operating cash flow on a sustainable basis?
