Banks are a very significant component of economic development for any company that wishes to grow. They play a major role in providing credit facilities that enable most firms to run and remain profitable. However, most banks take a very cautious approach in their lending role because of the danger of payment defaults and an increase in non-performing assets (Bodenhorn, 2002). This paper focuses on the Cash is King, LAF case study and aims at making a lending recommendation based on the firm’s quantitative financial report. The paper also aims at describing why the cash budget is more significant to a bank than the accounting income in credit decisions.
From the quantitative analysis, the books of account for LAF represent a realistic and faithful status of the business based on the values of the assets and liabilities. However, a lending decision must incorporate a sensitivity analysis of the business. The analysis is significant in determining the sustainability of a business under different changing conditions and economic situations (Onyiriuba, 2016). The analysis, therefore, forecasts the effect of the firm’s input parameters on its resulting performance.
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Some of the factors that make up a sensitivity test analysis are the financial ratios like the liquidity ratios, asset and debt management ratios, and profitability ratios. From the quantitative analysis, LAF’s progress is good over the three months under study. The firm’s ratios are as below
Return on assets = Net Income/Total Assets = 277288/2002520 = 0.14 = 14%. The ROA indicates the level of the profitability of a firm’s assets and how they generate revenue. A ROA of 14% is quite impressive since that implies a higher return on the assets for the firm.
Debt ratio = Total Debts / Total Assets = 56,700 / 2,002,520 = 0.028 = 2.8%. The debt ratio indicates the value of the firm’s assets that are provided through credit. LAF’s debt ratio is great and makes it easier to borrow more.
Current ratio = Current Assets/Current liabilities = 320,100/56700 = 5.65. The current ratio indicates that the firm is in optimal performance and implies that it has more than five times current assets than liabilities to cater to its obligations.
Given the ratios indicated, the firm is doing extremely well and Kent bank can advance a loan of $60,000 at a rate of 16% which it would be able to pay given its level of profitability. However, Kent bank must be cautious as the firm's figures appear to be too good to be true. Due diligence of the books must hence be done to establish the financial records as a true representation of the firm’s financial status.
Kent Bank must carry out a further review of LAF’s cash budget. The cash budget is more preferable in lending as compared to the firm’s accounting income. A cash budget facilitates analysis of a firm’s sustainability as a going concern. The cash budget analysis entails an arrangement of the business cash inflows as well as outflows for each particular business cycle (Jury, 2012). That is significant in enabling the firm to follow through with its cash requirements throughout their financial year, and it is on such basis that a lender would know the true financial needs of a firm unlike through the accounting income. The budget hence assists lenders to determine whether a firm would have sufficient funds to continue their operations since liquidity is very significant.
References
Bodenhorn, H. (2002). Property Banking, Free Banking, and Branch Banking. State Banking in Early America, 249-286.
Jury, T. D. (2012). Cash Flow Analysis and Performance Measurement. Cash Flow Analysis and Forecasting, 215-221.
Onyiriuba, L. (2016). Cash Flow Analysis and Lending to Corporate Borrowers. Emerging Market Bank Lending and Credit Risk Control, 393-417.
