Balance sheet Items to look for when extending credit?
Hey guys what items on the balance sheet do you look at to determine if a company is credit worthy? i.e. financial health
1) I would look at the current assets to current liabilities
2) Also total debt / assets
Am I on the right track? what else do you guys look for?
You need to look at operating income and cash flow metrics as well (Debt/EBITDA, FCF/debt). Balance sheet values of assets can be unreliable.
Also, there's the Altman Z-score (lifted from Wikipedia): The original Z-score formula was as follows: Z = 0.012T1 + 0.014T2 + 0.033T3 + 0.006T4 + 0.999T5.
T1 = Working Capital / Total Assets. Measures liquid assets in relation to the size of the company.
T2 = Retained Earnings / Total Assets. Measures profitability that reflects the company's age and earning power.
T3 = Earnings Before Interest and Taxes / Total Assets. Measures operating efficiency apart from tax and leveraging factors. It recognizes operating earnings as being important to long-term viability.
T4 = Market Value of Equity / Book Value of Total Liabilities. Adds market dimension that can show up security price fluctuation as a possible red flag.
T5 = Sales/ Total Assets. Standard measure for sales turnover (varies greatly from industry to industry).
Altman found that the ratio profile for the bankrupt group fell at -0.25 avg, and for the non-bankrupt group at +4.48 avg.
http://en.wikipedia.org/wiki/Altman_Z-score
Note that only T1 and T2 are strictly speaking balance sheet items (T4 to some extent).
Thank you KP
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