Introduction
Creditworthiness refers to the capacity of a person or a firm to repay its debt when it becomes due. It is the ability to repay not only the principal amount but also the interest charged up on it. Every creditor wants the repayment of their credit with certain percentage of interest on it. Hence the credit return liability of the borrower will be more than the principal amount they received. The borrower wants to repay the amount they received as debt with interest charges within specified time. Interest is the charge for the usage of money.
For carrying out any business activity a person or a firm requires money. When money is used for business activity it is called finance. It can be say that finance is the life blood of any business. Without adequate finance no business can be carried out profitably. So finance is required by business concern for its working. The finance so needed is procured by business concern through various sources. The source of finance may be the entrepreneurs own fund or outsiders’ money. The external source of finance includes creditors, banking institutions and other financial institutions.
For getting the external finance it requires some kinds of guarantee with regard to the repayment of the finance. The banking institutions always check the creditworthiness of their customers before taking decision to grant loan to them. For finding the credit return ability of the customers they adopt the method of credit rating techniques. For a business concern it is very crucial to demonstrate their creditworthiness ability for getting loans and advances.. Usually for a business concern the external finance is supplied by investors on the guarantee of their goodwill. Because of requirement of huge finance the firm cannot assure all their borrowings with landed or fixed asset.
They borrow money on the power of their good financial position or over its creditworthiness. Systematic analysis of a companies creditworthiness is a useful part of company’s medium term planning. The company assure their debt repayment ability using credible business plans and historical cash flows. They also wants to assure the profitability of their business. Without profitability there is no creditworthiness. Hence the term creditworthiness is important in business world.
Here an important question arises that how the creditors calculate or determine the creditworthiness of a business concern? What are the methods used by them for calculating creditworthiness? Whether the methods used by them are reliable for taking decision on further lending. We also discuss the factors affecting creditworthiness.
Academic objectives
The subject, measurement of credit worthiness of a company is required to be analysed in detail. The objectives of the study are as follows:
- To understand the creditworthiness of the selected company.
- To know the factors affecting creditworthiness of a firm.
- To find out the methods to make improvement in the credit worthiness
The indicators of creditworthiness of a firm is payment of bills on time, paying down existing debt, refrain from taking of new debt etc. The regular payment of dividend to the shareholders is a good indicator of creditworthiness of the firm. Able to maintain prompt payment and good standing for a reasonable period of time is a good indicator of creditworthiness. The factors that adversely affect creditworthiness of the firm are bankruptcy, late payment of bills and collections. The study of credit history of the firm will help to understand the attitude of the firm towards the creditors in the previous years
By the term measurement of creditworthiness it indicates not only the existing repayment capacity of the firm but also the attitude of the firm towards the payment of debt in time.
A company’s financial resources include both internal and external source. Internal source include share capital and reserves& surplus. Equity shares and preference shares are included in the term share capital. External source of finance include debenture, loan and advances, bills payable etc. Shareholders want to get regular and adequate dividend on the shares held by them. Debenture holders want to get return of their investment with proposed rate of interest. Loans and advances are required to be repaid on time. Measurement of creditworthiness enables the outsiders to take a decision regarding the purchase of shares and debentures of the company.
To the banking institutions it enables them to take decisions regarding granting of loans and advances to the company. For the measurement of creditworthiness of a firm various methods are adopted ‘which include comparative financial statement, comparative income statement, ratio analysis, cash flow statement and fund flow statement.
By analysing the financial statements of the firm through ratio analysis will help to derive conclusions regarding the financial stability of the firm. Both short term and long term solvency position can be analysed through ratio analysis. Comparative study of the financial statement of different years of the firm will help to know the growth rate of the firm which is an indicator of creditworthiness. The financial position of the firm in the industry can be analysed by comparing the statements of the firm with other firm’s in the same industry. Hence the study of measurement of creditworthiness is important.
Literature Review
For avoiding risk related with credit return all financial institutions will evaluate the repayment capacity of their lending customers before granting credit to them, by various ways. Creditworthiness measurement is done by the enterprise themselves especially for taking short term decisions. Enterprises are forced to make choices about their business relationships regardless of their business activity, legal form, ownership, or size.
Because of severe risks and the need to identify new opportunities and build trust, the selection made by evaluating their potential and existing business partner’s creditworthiness is becoming crucial. External credit ratings made by several agencies are a very important information commodity. Alternatively many enterprises are evaluating the creditworthiness by themselves especially when taking short term decisions.
Contemporary enterprises, which are aware of the severe financial and non-financial risks involved, have different values, expectations and understanding of success. Therefore, the criteria used in the evaluation of creditworthiness during the selection processes of business partners differ. For so-called internal ratings, several methodologies are in use. As the evaluation of creditworthiness is a very complex goal multi -criteria decision- making methods should be applied in which both quantitative and qualitative criteria are taken into consideration.
The creditworthiness is used by banks for assessing which enterprise was worth a credit. Credit rating is one of the important methods used by banking institutions to know their customers financial stability. A credit rating assesses the credit worthiness of an individual, corporation, or even a country. Credit ratings are calculated from financial history and current assets and liabilities. Typically, a credit rating tells a lender or investor the probability of the subject being able to pay back a loan. However, in recent years, credit ratings have also been used to adjust insurance premiums, determine employment eligibility, and establish the amount of a utility or leasing deposit.
A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates, or the refusal of a loan by the creditor.
For the outsiders, the financial statements prepared by the firm at the end of the accounting period are the main source of information about the firm’s current financial position. Financial statements are the published result of working of the company at the end of the accounting year. The outsiders of the firm depends these annual statement for making decision relating to the firm such as purchase of shares and debentures and granting of loans and advances.
Financial statement analysis is one of the important methods of creditworthiness measurement. Financial statement includes position statement and income statements. Position statement indicates the current financial position of an enterprise. Annual statements of a particular year cannot provide information about the firm’s position in the industry or its growth rate. Conclusion can be made only after comparing the statements with other firm’s statement in the same industry or by comparing statements of different years.
By comparing the current year statement with those of previous year or a base year it can conclude whether the current financial position of the company is good or not. Comparison can be made with other firm’s financial statement in the same industry. The most common financial statements include the balance sheet, the income statement, the statement of changes of financial position and the statement of retained earnings.
Analysis of financial statement
Financial statements are the end product of financial accounting. They are statement containing financial information of business enterprise. These statements containing detailed summaries of detailed information about the financial position and performance of an enterprise. Traditionally financial statement contain two statements namely income statement and position statement. Analysis of these two, statements will give information regarding the creditworthiness of the firm.
Financial statement analysis is the process of examining relationships among financial statement elements and making comparisons with relevant information. It is a valuable tool used by investors and creditors, financial analysts, and others in their decision-making processes related to stocks, bonds, and other financial instruments. The goal in analyzing financial statements is to assess past performance and current financial position and to make predictions about the future performance of a company. Investors who buy stock are primarily interested in a company’s profitability and their prospects for earning a return on their investment by receiving dividends and/or increasing the market value of their stock holdings.
Creditors and investors who buy debt securities, such as bonds, are more interested in liquidity and solvency: the company’s short-and long-run ability to pay its debts. Financial analysts, who frequently specialize in following certain industries, routinely assess the profitability, liquidity, and solvency of companies in order to make recommendations about the purchase or sale of securities, such as stocks and bonds. Analysts can obtain useful information by comparing a company’s most recent financial statements with its results in previous years and with the results of other companies in the same industry. Three primary types of financial statement analysis are commonly known as horizontal analysis, vertical analysis, and ratio analysis.
Horizontal Analysis
When an analyst compares financial information for two or more years for a single company, the process is referred to as horizontal analysis, since the analyst is reading across the page to compare any single line item, such as sales revenues. In addition to comparing dollar amounts, the analyst computes percentage changes from year to year for all financial statement balances, such as cash and inventory. Alternatively, in comparing financial statements for a number of years, the analyst may prefer to use a variation of horizontal analysis called trend analysis. Trend analysis involves calculating each year’s financial statement balances as percentages of the first year, also known as the base year. When expressed as percentages, the base year figures are always 100 percent, and percentage changes from the base year can be determined.
Vertical Analysis
When using vertical analysis, the analyst calculates each item on a single financial statement as a percentage of a total. The term vertical analysis applies because each year’s figures are listed vertically on a financial statement. The total used by the analyst on the income statement is net sales revenue, while on the balance sheet it is total assets. This approach to financial statement analysis, also known as component percentages, produces common-size financial statements. Common-size balance sheets and income statements can be more easily compared, whether across the years for a single company or across different companies.
Tools or techniques of analysis
Comparative financial statements
One of the techniques of financial statement analysis is the preparation of comparative financial statement of the same concern for two accounting periods or for two or more concern for a particular period. In this statement figures of two or more periods are placed side by side to facilitate comparison
Comparative income statement
The income statement discloses net profit or net loss resulting from the operations of business. A comparative income statement will shows the absolute figures for two or more periods , the absolute change from one period to another and if desired, the changes in terms of percentages. Since the figures for two or more periods are shown side by side the reader can quickly ascertain whether sales have decreased or increased. This statement helps in deriving meaningful conclusion
Comparative balance sheet
Comparative balance sheet as on two or more different dates can be used for comparing assets and liabilities and finding out any increase or decrease in these items. These facilitate comparison of figures of two or more periods and provide necessary information which may be useful in forming an opinion regarding the financial conditions as well as progressive out look of the concern
The analysis of financial statement of the firm is an important method of creditworthiness measurement. Comparison of financial statements forms the basis for much financial analysis. Four main types of comparison are made:
- comparison of statements for the enterprise between successive years
- comparison of a firm’s statements with those of a specific competitor
- comparison of a firm against an industry standard and
- comparison with a target, such as a company’s budget.
Comparisons between different organizations may be difficult or even meaningless because of differences in
- size of the organization
- type of organization and
- accounting methods used by the organization.
Often, both the size and type of organization will dictate the kind of accounting methods used. The Uses of Financial statements-by Ben Best.
Common Size Financial Statements
Common size ratios are used to compare financial statements of different size companies or of the same company over different periods. By expressing the items in proportion to some size related measure, standardized financial statements can be created revealing trends and providing insight into how the different companies can be compared.
The common size ratio for each line on the financial statement is calculated as follows:
Common size ratio = item of interest /reference item
For example, if the item of interest is inventory and it is referenced to total assets (as it normally would be) the common size ratio would be:
Common size ratio for inventory = inventory/ total assets
The ratios often are expressed as percentages of the reference amount. Common size statements usually are prepared for the income statement and balance sheet, expressing information as follows
- Income statement items – expressed as a percentage of total revenue
- Balance sheet items – expressed as a percentage of total assets
- Common size statements can also be used to the firm to other firms
- Common size financial statements can be used to compare multiple companies
at the same point in time. A common-size analysis is especially useful when comparing companies of different sizes. It often is insightful to compare a firm to the best performing firm in the industry (benchmarking).A firm also can be compared to its industry as a whole. Comparative statements provide a quick overview of the financial position of the firm in the industry
Limitations
The limitations of this method are as follows;
- Different accounting policies may be used by different firms or within the same firm at different points in time. Adjustments should be made for such differences.
- Different firm may use different accounting calendars, so the accounting periods may not be directly comparable.
Common size financial statement analysis
This is a method used by interested parties such as investors, creditors, and management to evaluate the past, current, and projected conditions and performance of the firm Horizontal analysis is used to evaluate the trend in the accounts over the years, while vertical analysis, also called a Common Size Financial Statement discloses the internal structure of the firm. It indicates the existing relationship between sales and each income statement account. It shows the mix of assets that produce income and the mix of the sources of capital, whether by current or long-term debt or by equity funding
Two types of comparisons
- Industry comparison. The ratios of a firm are compared with those of similar firms or with industry averages or norms to determine how the company is faring relative to its competitors. Industry average ratios are available from a number of sources
- Trend analysis. A firm’s present ratio is compared with its past and expected future ratios to determine whether the company’s financial condition is improving or deteriorating over time.
Ratio Analysis
It is one of the most useful and common method of analysing financial statement. As compared to other tools of financial analysis the ratio analysis provides very useful conclusion about various aspect of the working like financial position, solvency, liquidity and profitability of an enterprise.
Ratio Analysis enables the business owner/manager to spot trends in a business and to compare its performance and condition with the average performance of similar businesses in the same industry.
Balance Sheet Ratio Analysis
Important Balance Sheet Ratios measure liquidity and solvency (a business’s ability to pay its bills as they come due) and leverage (the extent to which the business is dependent on creditors’ funding). They include the following ratios:
Liquidity Ratios
These ratios indicate the ease of turning assets into cash. They include the Current Ratio, Quick Ratio, and Working Capital.
Current Ratios
The Current Ratio is one of the best known measures of financial strength. It is figured as shown below:
The main question this ratio addresses is: “Does the business have enough current assets to meet the payment schedule of its current debts with a margin of safety for possible losses in current assets, such as inventory shrinkage or collectable accounts?” A generally acceptable current ratio is 2 to 1. But whether or not a specific ratio is satisfactory depends on the nature of the business and the characteristics of its current assets and liabilities. The minimum acceptable current ratio is obviously 1:1,
Quick Ratios
The Quick Ratio is sometimes called the “acid-test” ratio and is one of the best measures of liquidity. It is figured as shown below:
The Quick Ratio is a much more exacting measure than the Current Ratio. By excluding inventories, it concentrates on the really liquid assets, with value that is fairly certain “An acid-test of 1:1 is considered satisfactory unless the majority of the quick assets are in accounts receivable, and the pattern of accounts receivable collection lags behind the schedule for paying current liabilities.
Working Capital
Working Capital is more a measure of cash flow than a ratio. The result of this calculation must be a positive number. It is calculated as shown below:
Working Capital = Total Current Assets – Total Current Liabilities
Bankers look at Net Working Capital over time to determine a company’s ability to weather financial crises. Loans are often tied to minimum working capital requirements.
A general observation about these three Liquidity Ratios is that the higher they are the better, especially if you are relying to any significant extent on creditor money to finance assets.
Leverage Ratio
This Debt/Worth or Leverage Ratio indicates the extent to which the business is reliant on debt financing (creditor money versus owner’s equity):
Generally, the higher this ratio, the more risky a creditor will perceive its exposure in the business, making it correspondingly harder to obtain credit.
Income Statement Ratio Analysis
The following important State of Income Ratios measure profitability:
Gross Margin Ratio
This ratio is the percentage of sales dollars left after subtracting the cost of goods sold from net sales. It measures the percentage of sales dollars remaining (after obtaining or manufacturing the goods sold) available to pay the overhead expenses of the company.
Comparison of a firm’s business ratios to those of similar businesses will reveal the relative strengths or weaknesses in the firm’s business. The Gross Margin Ratio is calculated as follows:
Reminder: Gross Profit = Net Sales – Cost of Goods Sold
Net Profit Margin Ratio
This ratio is the percentage of sales left after subtracting the Cost of Goods sold and all expenses, except income taxes. It provides a good opportunity to compare company’s “return on sales” with the performance of other companies in that industry. It is calculated before income tax because tax rates and tax liabilities vary from company to company for a wide variety of reasons, making comparisons after taxes much more difficult. The Net Profit Margin Ratio is calculated as follows:
Debt Management Ratios
Debt management ratios are used to find the ability of the firm in management of debt.
Important debt management ratios are debt ratio and TIE ratio, debt ratio is the ratio of total debt to total assets. It is the indicator of long term solvency position of the firm. It measures the percentage of funds provided by creditors. Creditors prefer low debt ratio because lower the ratio the greater the cushion against creditors losses in the event of liquidation. Stock holders on the other hand may want more leverage because it magnifies the expected earnings.
Inventory Turnover Ratio
This ratio reveals how well inventory is being managed. It is important because the more times inventory can be turned in a given operating cycle, the greater the profit. The Inventory Turnover Ratio is calculated as follows:
Accounts Receivable Turnover Ratio
This ratio indicates how well accounts receivable is being collected. If receivables are not collected reasonably in accordance with their terms, management should rethink its collection policy. If receivables are excessively slow in being converted to cash, liquidity could be severely impaired. Getting the Accounts Receivable Turnover Ratio is a two step process and is calculated as follows:
Return on Assets Ratio
This measures how efficiently profits are being generated from the assets employed in the business when compared with the ratios of firms in a similar business. A low ratio in comparison with industry averages indicates an inefficient use of business assets. The Return on Assets Ratio is calculated as follows:
Return on Investment (ROI) Ratio
The ROI is perhaps the most important ratio of all. It is the percentage of return on funds invested in the business by its owners. In short, this ratio tells the owner whether or not all the effort put into the business has been worthwhile. If the ROI is less than the rate of return on an alternative, risk-free investment such as a bank savings account, the owner may be wiser to sell the company, put the money in such a savings instrument, and avoid the daily struggles of small business management. The ROI is calculated as follows:
These Liquidity, Leverage, Profitability, and Management Ratios allow the business owner to identify trends in a business and to compare its progress with the performance of others through data published by various sources. The owner may thus determine the business’s relative strengths and weakness in the industry.
Cash flow statement
The cash flow statement reflects a firm’s liquidity or solvency. The balance sheet is a snapshot of a firm’s financial resources and obligations at a single point in time, and the income statement summarizes a firm’s financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues. The cash flow statement includes only inflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These non cash transactions include depreciation and write-offs on bad debt. The cash flow statement is a cash basis report on three types of financial activities: operating activities, investing activities, and financing activities..
The cash flow statement is intended to
- provide information on a firm’s liquidity and solvency and its ability to change cash flows in future circumstances
- provide additional information for evaluating changes in assets, liabilities and equity
- improve the comparability of different firms’ operating performance by eliminating the effects of different accounting methods
- indicate the amount, timing and probability of future cash flows
Methodology
Scope of the Research
The subject creditworthiness measurement of company is an important topic to go under research because it is important not only to the investors but also to the business world as a whole. Every business concern wants finance for their working. The financial requirement of the business is met by the firm through various sources. The source of finance may be external or internal to the business. The external source of finance is mainly banking institutions. Bank will be required to have historical credit information on their lending customers. This information is needed by them to evaluate their customer’s creditworthiness. For this they use credit scoring of their customers. A company that does not score well in a banks credit risk assessment may faced difficulties in getting finance at subsidized rate..
Systematic analysis of a company’s creditworthiness is a useful part of its medium term planning. The creditworthiness must be a management priority.
With most investments an individual or business spends money today with the expectation of earning more money in the future.
Basic methodology
For carrying the research on measuring the creditworthiness of a company here we use the method of case study analysis. Case study method is a popular method used for drawing conclusion by analyzing the selected sample and generalization of it. The data used here is the financial statements of The Tata Chemicals.
Design and Implementation of the Inquiry
Definition of research problem:- The creditworthiness of the selected company is required to be measured by the analysis of financial statement. The factors that affecting the creditworthiness of the company is required to be point out in detail. It is also needed to suggest the ways through which the creditworthiness can be improved.
Estimation of the value of information to be provided by research:-The financial statement analysis will help us to derive a conclusion regarding the creditworthiness of the company. Ratio analysis is an accurate method of statement analysis. Through ratio analysis we can calculate both short term and long term solvency of the firm separately. it also helps to know the profitability and financial; growth of the firm. However the research result may be affected by the data insufficiency. The result may also affected by the limitations of analyzing method.
Data collection method:- The data used for the research is collected from the annual working report of the company which is published for informing the shareholders and investors about the working of the company through internet. It is a secondary data about the financial position of the company.
Measurement techniques:- For analyzing the data we use ratio analysis method. The data are compared and verified by changing them into ratios. for finding short term liability current ratio analysis is used and for finding the long term solvency debt equity and proprietary ratios are used. For finding the profitability the gross profit and net profit ratios are used.
Sources of Bias
The research work is based on the case study of a selected company. The data used for analysis is only a.
Limitations of research process
The research work on creditworthiness measurement of company is affected by various limitations. The major limitation of this research process is as follows
Limitation with regard to data collection
Here the data used for creditworthiness measurement is the published financial statement of the company through internet. The financial statement are published by the company to inform the shareholders and ,investors of the company and the public about its financial position and performance during the past accounting year. Every company presents their financial statement with the intension to make goodwill to their business. So the managers may adopt window dressing techniques to make the statement showing a good financial position. To avoid the competitors sometimes they may hide their actual financial position and show a position lower than their actual position. So the statements provide only that information which is published by the company.
The balance sheet provides only a brief summary of the assets and liabilities owned and owed by the company during the financial year. the detailed information about the components of the assets and liabilities are not get from these statements. Only an outline of the balance sheet items is get from the statement. They do not express what the elements of current assets and current liabilities are. They also not show the details of share capital. The profit and loss account fails to provide information with regard to opening stock, purchase, and closing stock. It is only a brief summary of the working of the company during the past accounting year.
The analyzing method used here is ratio analysis. A major limitation of ratio analysis is that a particular ratio cannot be regarded as an indicator of good or bad performance. It only provides a clue to be further proved. Ratio of any particular period will not be much helpful to make conclusion. Ratio will not reveal all relevant information about the business operations. They help in providing only a part of the information needed in the decision making process. Ratios are only a clue to draw conclusion. For knowing the short term solvency we use current ratios. But current ratio does not indicate the liquidity position of individual component of current assets Even if the ratio is favorable the firm may be in financial trouble because of more stock and work in progress which are not easily realizable into cash.
Findings and Analysis
Following is the Balance sheet and income statement of “The Tata Chemicals” for the year ended 31st March 2005 and 2004.
Balance sheet
Summarized balance sheet as on 31st March, 2005
Summarised profit and loss account for the year ended 31 March, 2005
Key ratios
Analysis of Balance Sheet and Income Statement of Tata Chemicals for Finding Its Creditworthiness
Ratio analysis is used here for finding the creditworthiness of the firm.
Short term solvency ratio
Current ratio =current asset / current liability
In the year 2005 current ratio of the co.
=1172.63 /353.38 = 3.318
In the previous year 2004 it is 1.97 (i.e. 871.38 / 442.03)
Long term solvency ratio
Debt – equity ratio =debt / equity or total debt /net worth
Debt – equity ratio of the company in the year 2005
=1324.22 /1997.84 =66.28 %
In the previous year it is 37.6 % (i.e. 765.54 /2035.34)
Proprietary ratio = Share holders fund / total assets
Proprietary ratio of the company in the year 2005
= 1997.84 /3675.44 =0.54
In the previous year it is 0.62 ( I. e 2035.34 /3242.91 )
Profitability ratios based on sales of the company
Gross profit ratio = gross profit / sales * 100
G/P Ratio of the company in the year 2005
=455/ 3008.14 *100 =15.12 %
In the previous year the G/P Ratio of the co. is 13.40 ( i.e. 341 /2544.15 * 100)
Net profit ratio =Net profit /sales *100
Net profit of the co. in 2005
=340.55 /3008.14 * 100 =11.32 %
In the previous year it is 8.66 %( I.e. 220.53 /2544.15 * 100)
Profitability ratio based on investment of the company
Return on investment or return on capital employed =Earnings before interest and tax /Net capital employed *100
ROI ratio of the company in 2005
= 455 /3322.06 *100 = 13.69 %
In the previous year it is 12.2% (i.e. 341.84 /2800.88* 100)
Return on share holders fund =Net profit after interest and tax / share holders fund * 100
=340.55 /1997.84 *100 =17.04 %
In the previous year it is 10.83 % (i.e.220.53 /2035.34 *100)
Interpretation of ratio analysis
Current ratio of the company in the year 2005 is 3.318 and it is 1.97 in the previous year 2004.It shows that there is an increase in current ratio of the company in 2005 as compared to the previous year. That is the position of current asset level of the company against its current liability level is highly improved when compared to previous year. But when compared to industry average current ratio which is 4.2 the company’s ratio is not better. So it can conclude that the company’s short term solvency financial position is not satisfactory to the short term creditors and investors when compared to other firm’s position in the industry. The company wants to increase their current asset level against it’s current liability to assure their short term creditworthiness.
The debt – equity ratio of the company in the year 2005 is 66 % and it is 37.6 % in 2004.It shows that the debt equity ratio of the company expresses a rising trend. Usually the long term creditors of the company like a lower debt equity ratio because it is the indicator of a relatively favorable position to the creditors at the time of liquidation. So the rising trend in the debt – equity ratio indicates that the long term creditors and investors of the company is in a high risky position with their investment.
The industry average debt –equity ratio is 40%. So when compared to the long term investors of other firms in the industry the long term investors of Tata chemicals are in high risk. Hence for assuring the long term creditworthiness to the investors the company is required to increase their share holders fund to maintain a lower debt – equity ratio.
They required stopping further borrowing before additional share issue to assure their long term creditworthiness.
The proprietary ratio of the company in the year 2005 is 0.54 and in 2004 it is 0.62.
This ratio shows a declining trend when compared to previous year. It indicates that the contribution of share holder sin the total asset of the company is decreased when compared to previous year. Usually creditors wishes a high proprietary ratio which is an indicator of relatively favorable position to the creditors at the time of liquidation.So the declining trend in proprietary ratio is not at all favorable to the creditors in case of long term solvency of their funds. So to assure the long term creditworthiness the company wants to increase their shareholders contribution in the total assets of the company.
The profitability ratio of the company is also not in a favorable position. The gross profit ratio of the company in the year 2005 is 15.12 % only in the previous year it was 13.4%. The rising trend in gross profit ratio indicates that the company improving in its sales management. But the current gross profit ratio of the firm is not in a better position. as compared to other firm’s ratio in the industry. So the company wants to decrease their direct expenses to assure a better gross profit.to the business.
The net profit ratio of the company also show a poor position. in 2005 it is 11.32% only. though there is a slight increase in the net profit ratio when compared to previous year the current level is not good when compared to other firm’s net profit ratio in the industry.so the company wants to improve it’s working by decreasing the expenditure relating to the business and increasing the profitability by using good management of funds.
The return on investment ratio of the company is showing an increasing trend when compared to previous year. The company wants to keep this rising trend to increase the profitability and creditworthiness of the firm. The return on share holders fund is also showing an improving performance. It is a good indicator of the growth of the firm’ s financial position.
When taking the ratios together we can conclude that the firm’s short term creditworthiness is not satisfactory. The firm may be in financial trouble.to meet it’s short term debt when they become due. The long term creditworthiness of the firm is also not satisfactory. The long term creditors of the company is in high risky with their investment because their contribution in the business is much more than the share holders fund. But the share holders of the company is in a better position
Conclusion
The detailed study of the subject creditworthiness measurement of company reveals that the creditworthiness measurement is an important task to the creditors and investors of the company before taking decision to invest or grant credit to the company
It is a crucial task required to be carried out by them because a creditworthy company alone can assure the repayment of their debt within the time period with percentage of interest. Creditworthiness measurement is important not only to the investors and creditors. It is important to the company itself because without the ability to repay debt they cannot get finance from the external sources. The share holders also want to know the creditworthiness ability of the concern. They purchased shares on the expectation of dividend income. They also want the realization of their shares when the company becomes liquidated.
Only a creditworthiness firm can declare regular and adequate dividend to the share holders and assure the realization of their shares when they becomes liquidated. Thus creditworthiness measurement is important to the share holders also. The banking and other financial institutions assure the creditworthiness of their customers before granting loans to them. It is done for avoiding the risk of bad debt. For the measurement of creditworthiness of customers they adopt the technique of credit rating.it helps them to understand the financial stability of their customers.
For finding the credit return ability of a concern we use the method of analyzing the balance sheet and profit and loss account of the company. The analysis of these statement helps us to derive a conclusion regarding the creditworthiness of the firm. The financial statement can be analyzed by using various methods. Comparison of income statement and position statement with those of previous year or those of other firms in the industry is helpful to know the growth rate of the firm and their financial improvement. Ratio analysis method helps to find out the short term and long term creditworthiness of the company separately.
The short term creditworthiness is measured by analyzing current ratio and long term creditworthiness is measured by analysing leverage ratios. Such as debt – equity ratio, proprietary ratio and capital gearing ratio. The ratio analysis is also to finding the profitability of the company in the accounting year.