Company Analysis - Subjective Parameters

7/31/2019 Company Analysis - Subjective Parameters

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Company Analysis

There are many subjective or non-quantitative factors that create default risk. These factors areimportant to the process of credit evaluation and can make a big difference to the actual risk score of thecompany.

1. Management Compet encyThe competency of the management of the company is one of the most important factors in decidinghow the company fares over the next few years.

Though it is impossible to include all the factors of management into a score, some basic factors can be

considered:

a) Professional qualifications of senior management like CEO, MD & heads of business units.b) The experience of the management within the same industry more experience within the domain of

the company is a key strength for many companies and reduces operational risk of the company.

c) Any ownership (ESOPs, shares etc.) that the management has in the company. Any managementtends to more proactive and involved when they have a stake in the profits of the company.

d) Past track record of senior managemente) Decisions taken in the past 2-3 years and their impact (if relevant)2. Prom ot er and Management Track RecordThe basic things to consider when evaluating the promoters of the company remain the same as for

management. But there are a few extra points we need to consider for the promoters:

a) Reputation of promoter Especially relevant for countries like India, credit evaluation experts arealways keen on finding out the reputation of the promoters among suppliers/vendors etc. This factor

is especially important for smaller companies, where the financials might not show the real picture.

b) Promot er Shareholding Banks are typically wary of both very tightly held companies andcompanies that have a very low promoter stake. When promoters have a low stake their involvement

in the company and its well being is likely to be low, too. In cases where the promoter stake is too

high (say >80%), the company does not go through the rigour of having to answer to investors; the

corporate governance structure is not well tested.

3. Concentr ati on RiskConcentration Risk is the risk that arises from the company being too dependent on either customers or

suppliers; or, in some cases, on revenues from certain geographies.

Customer Concentrat ion - This is the risk of having too much dependence on a single or group of

customers. Heres an indicative table with risk scores for the customer concentration for any company.

The actual weight or range would differ in banks/rating agencies


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Parameter I nput Risk Score(/ 10)

% contributed by top

customer

35 7

% contributed by top 5customers

65 6

No. of customers who form80% of the companysrevenue base.

12 5

Weighted Risk Score 6

Supplier Concentrat ion - A strong vendor base and supply chain can be a make or break factor for alot of companies, esp. in highly competitive sectors like automobiles. For credit analysis of a company thisis one of the most important factors, that dictates how much the company is affected by fluctuations inprices of its raw materials.

Heres an indicative table with risk scores for the supplier concentration for any company.

Parameter I nput Risk Score(/ 10)

% contributed by topcustomer

35 7

% contributed by top 5customers

65 6

No. of customers who form80% of the companysrevenue base.

12 5

Weighted Risk Score 6

4. Operational ProfileIn the operational profile, you will have to analyze:

The Basic Business Prof ile

Scale in comparison to average industry size calculate Capacity/Average Capacity of top 5players

Maturity of the company within the industry how far is the company on its learning curve? Diversification How diversified is the company? How correlated are the products of the

company? For e.g a textile company might have various product lines from polyester to cotton,

but all these products will have a similar fate in case of a demand shrinking in textile export

markets.

Cost efficiency How cost efficient is the company, as compared to similar companies in theindustry? We can judge this by looking at the COGS (cost of goods sold) of the company as a

ratio of the sales, and comparing it to its peers. This is a direct comparative measure.

Product Strengt h

The need for the product How strong is the need for the product? Has the company identifiedproduct development streams? (new innovations/ further development of product and expansion

of target audience)


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Differentiation How differentiated is the company from other companies within the sameindustry? This is a key factor that lends a lot of credibility to company projections.

Is there any other unique competitive advantage the company has? This could be, for example,location, or any similar advantage difficult to emulate. Any such advantage will lead to a lower

risk score for the company.

Production Profil e

Technology We need to see how technologically advanced the company is in terms ofproduction or core work. One needs to judge the risk of the technology being used by the

company, becoming obsolete.

Patents/Licenses As a credit analyst, you need to look into whether the company has anypatents or licenses that give it a competitive edge. We also need to know if any patents are

expiring in the immediate future. This could be a risk to the revenue flows/pricing of the

companys products.

Labour Issues can be a big problem for manufacturing companies with strong labour unions.The lender needs to be aware of any labour issues that the company is facing or has faced,which could recur.

Past Track Record The companys past performance in terms of delivering on time, and itscapability to produce advanced products needs to be looked at as a risk, especially if the

company is foraying into new business or in case of capacity expansion.

Utilizati on and realization

Utilization, realization and their trends can be a big differentiator. The company would get a strong rating

if its capacity utilization as well as realization is higher than industry standards.

Value chain str ength s

There are two key strengths that one has to judge as a credit analyst

Customer relationships Customer relationships that are strong and have been steady over time, are

intangible but important assets to any company. These need to be evaluated and the company rated on

its ability to form and consolidate customer relationships.

Backward integration - Any backward integration is considered a strength in the value chain as the

company is assured of support in times of need. Also, in many cases it reduces costs and makes the

company more competitive.

Cost struct ure and contr ol

For any lender, the best borrower is one who is frugal in his use of money. This holds for any corporate

big or small, mature or new in the industry. The RM/credit analyst needs to look at how the company has

been controlling costs and what are the trends in this respect. Finally, a rating has to be given to this

aspect based on industry benchmarks and trends.

Documents

Company Analysis - Subjective Parameters