Gone in 60 seconds: a credit risk analysis in less than one minute
To evaluate the creditworthiness of a client or partner we often have just a few seconds and no time or opportunity to perform a thorough credit risk analysis.
In less than a minute s-peek provides a free assessment of the company’s economic and financial situation. Yet, if we look a little deeper and had only 60 seconds to evaluate the counterparty creditworthiness, which ratios should we absolutely check?
As first we need to verify the company’s solvency.
We have no time to waste, so let’s quickly check the Total Leverage ratio (total liabilities / net equity). This ratio measures the company’s indebtedness towards banks and other lenders: if the outcome is 1, the company funds the business activities with equity only; the more the value exceeds 1, the more the company resorts also to external sources (like bank credit).
Outcomes between 1 and 2 show an adequate sources’ proportion, while generally values above 3 may indicate a strong indebtedness.
.Let’s now analyze the profitability, i.e. the ability of the company to generate profits on the invested capital.
To prosper a company has to generate revenues. We therefore need to check the ROE (return on equity) ratio, which measures the shareholders’ profit margin achieved by the company without resorting to external credit.
The ROE ratio can be calculated by dividing the net incomes by the shareholders’ equity. The result must be benchmarked against the average values resulting from the sector comparison. Though, if the company has incurred losses, the value of the ratio will be negative (both in a quantitative and qualitative sense) regardless of the sector average.
We now have only 20 seconds left to check the compnay's liquidity.
Let’s first calculate the value of the Current Ratio, which measures a company’s ability to meet its short-term obligations. The Current Ratio compares the current assets, i.e. the company’s cash holdings and liquid assets (mainly stocks and receivables), with the current liabilities, i.e. the payables due within a year. The higher the value, the more the cash resources available to cover short-term debts. Outcomes between 1.5 and 2.5 are on average.
All the above-mentioned values have to be compared with the values of the companies operating in the same sector and country.
In s-peek’s Flash and Extended12M reports you can check the rating class assigned to each area, which already includes the data emerging from the sector comparison.
Time is up: by analyzing the above ratios you can perform in just one minute an initial credit risk analysis and estimate the counterparty’s creditworthiness.