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May 31, 2024
9 Free Financial Modeling Lessons
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They want a good return on their investment, so they consider anything that affects the safety and return of their capital. This includes cash flows and liquidity, but there are many things - some of them idiosyncratic to specific markets - that go into determining credit risk.
Getting repaid is the most important thing to any lender so coverage ratios are key: EBIT / Interest Expense or EBIT / (Principal + Interest Expense) measure borrower's ability to repay debt obligations. You could use EBITDA as the numerator for either of those ratios, but even though D&A is non-cash, the ratio ignores capex, so you have arguments for using either. Take a look at how capex intensive the borrower is and if they have a significant amount of deferred maintenance.
Most large companies can tap debt markets to roll debt forward, hence the reason for ignoring principal payments in the second ratio. If your borrower is smaller (or has lots of small bank debt that it can't easily take out) you may want to focus on principal and interest repayment. You should always capitalize leases to account for companies with low debt but significant operating leases. Take a look at your borrower's debt maturity schedule and be mindful of years with walls of debt.
Liquidity is tough to measure because companies can manipulate their cash position at year end if they have foreign debt facilities. Look at the statement of cash flows -- has the borrower been burning cash or building cash? Is the borrower amassing huge operating losses but levering up to build cash? Debit / EBITDA or EBIT is a good leverage ratio. Depending on industry, D/EBITDA north of 5x is a red flag.
A few final checks: Compare the maturity of the borrower's revolving facilities to its debt maturities / your loans. What is the rate on the buyer's revolver / other debt? Is it LIBOR + 100 bps or + 1000 bps? Have the borrower's other lenders continually extended / expanded credit facilities or have they shortened maturities, added covenants and taken liens on the borrower's assets? Take a cue from how your borrower's other lenders have been behaving.
Hope this helps -- good luck!
How many other produces they can sell them
getting a spot on the next equity / bond offering, mostly.
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