A bank goes through a series of thorough analyses before approving a loan, extending a credit line or increasing a customer's credit profile. It does so to reduce credit risk, monitor debt levels and ensure that borrowers are forthcoming with performance data when they submit financial statements and accounting ratios.
A bank pays attention to a potential borrower's liabilities before granting a loan application. It does so to evaluate how much money the prospective debtor currently owes and who the existing creditors are. By gauging liability trends, the bank makes sure it does not increase its own exposure to a single customer, a situation that banking specialists call being over-extended. For example, if a bank already has significant outstanding loans with a customer, extending more credit may result in over-extending.
Assets play a key role in a bank's lending decision. Given that assets represent resources a borrower will use to generate cash and repay the bank, loan officers appraise the debtor's existing assets to determine short-term solvency. Assets are part of a corporate statement of financial position, and run the gamut from customer receivable, cash and merchandise to computer hardware, real estate and factory equipment.
Bankers delve into a corporate borrower's statement of profit and loss to determine how much the business is generating in revenues. Loan officers pay special heed to revenue items because an adverse change in profitability trends could limit the company's ability to repay its debts. Dire scenarios such as temporary financial distress and bankruptcy might ensue, a situation lenders generally fret. A statement of profit and loss is also known as a statement of income, P&L or income statement.
A lending officer sifts through a company's P&L to see how the firm intends to produce income through its existing levels of administrative charges and manufacturing costs. The goal is to determine how the business can steer its operations in an economically sustainable way while curbing excessive spending. The balance may be difficult to strike, as corporate expansion plans and long-term investments generally call for significant expenses. But without those expenditures, the company could find it difficult to spur sales, innovate and grow market share.
For a banker, it's useful to glean solvency data from balance sheets and P&Ls, but the ultimate goal is to assess a borrower's cash flows. By studying liquidity movements, the financier makes sure the company has regular inflows of cash and that it will have sufficient money to settle its liabilities. A corporate cash-flow statement provides insight into a company's liquidity movements in operating, investing and financing activities.
- Missouri Small Business and Technology Development Centers: Financial Ratios
- State of New Jersey Department of Banking and Insurance: Personal Finance -- Frequently Asked Questions
- New York University, Stern School of Business; Financial Statement Analysis; Aswath Damodaran
- Morningstar: Introduction to Financial Statements