credit analysis and corporate failure prediction model case studies.pdf

8/17/2019 Credit analysis and corporate failure prediction model case studies.pdf

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GIMPA

CREDIT ANALYSIS AND CORPORATE FAILURE PREDICTION MODEL CASE STUDIES FOR

FINANCIALINSTITUTIONS

Exercise 1 [Case study]

Kofi Nyame & Sons Limited started business as a small wholesaler about 12 years ago, distributing

beer and spirits to most of the retail shops, bar and restaurants in Central Accra. Due to stiff

competition from other well-established distributors, the company saw the need to expand its activities

to the small towns and cities outside Accra. This expansion paid dividends as sales have grown so

rapidly in the last two years, pushing the business into a bigger size. As part of the strategy, some

depots in key towns and cities have been leased to hold regular supplies ready for distribution.

The company is run by Kofi Nyame 65 years, and assisted by his two sons, Kwame and Kojo both 32

and 26 years respectively. Kwame has been with the company for the past 3 years after resigning from

a leading pharmaceutical company. You also know he holds a first degree in Marketing from the

University of Ghana. Kojo joined the team recently after his national service. Kofi Nyame who is a semi-

literate has requested a meeting today during which the following were discussed:

(i) He is very pleased with the present performance of the company explaining that the

business owes its rapid expansion to the ingenuity of Kwame. As a result, he is preparing

to hand over the reins of management to Kwame.

(ii) Although Kofi Nyame and sons Limited continue to make good profits, the rapid expansion

has affected working capital and the brewery companies are not willing to extend further

credit. He would therefore want the bank to assist as the company account has been with

your bank since the inception of the company.

(iii) He plans to continue to keep his equity in the business for as long as possible even in

retirement. He would however want the bank to release its charge on his personal property

used as collateral for the company’s existing borrowings.

(iv) He would be grateful if the bank would increase the existing limit to GH¢350,000 against

the existing assets of stock and debtors which has increased in recent years.

Your enquiry revealed that Kwame, who is not yet married, has no property of his own. You already

mark a GH¢200,000 overdraft for Nyame and Sons Limited and is usually in excess of the limit. You

also hold a non-property debenture over stock and debtors supported by a surety mortgage over the

Kofi Nyame’s personal property which was last valued at GH¢300,000 three years ago.

Interest rates are 30% per annum for the financial market and the facility is to be payable in five years

time.

Required: You are required to respond to his request stating whether you will recommend the new

request.


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The information below relates to Kofi Nyame & Sons Limited:

KOFI NYAME & SONS LIMITED

Statement of financial position as at December 2011 2012 2013

GH¢ GH¢ GH¢

Current assets

Debtors 110,000 210,000 195,000

Stock 135,000 250,140 345,390

Total current assets 245,000 460,140 540,390

Current liabilities

Creditors 110,000 240,000 310,000

Hire purchase 2,000 2,000 2,000

Bank 70,000 135,000 188,000

Tax 8,000 10,000 5,000Directors loans 10,000 10,000 10,000

Total current liabilities 200,000 397,000 515,000

Net current assets 45,000 63,140 25,390

Non-current assets

Leasehold property 36,000 36,000 66,000

Fixtures and fittings 7,000 6,000 28,625

Motor vehicles 8,000 6,000 25,000

Total fixed assets 51,000 48,000 119,625

Long term HP 16,000 5,000 7,000

Net assets 80,000 106,140 138,015

Capital and surplus

Share capital 20,000 20,000 20,000

Profit and loss account 60,000 86,140 118,015

80,000 106,140 138,105

Statement of comprehensive income

Sales 900,000 1,950,000 3,802,500

Cost of sales 810,000 1,765,500 3,596,444

Gross profit 90,000 184,500 206,056

Administration and distribution expenses 57,000 127,100 140,625

Operating profit 33,000 57,400 65,431

Interest paid 8,000 14,500 21,000

Profit before tax 25,000 42,900 44,431

Tax 8,000 16,760 12,556Profit after tax 17,000 26,140 31,875


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Exercise 2 [Case study]

Lisa Limited is a company that deals in various brands of electronic appliances. The company was

established3 years ago and has being with your bank since inception. Most of the goods are imported

from the Far East and payments are usually made on a 90-day letter of credit basis. About 60% of the

sales are made to employees of public and private institutions.

About two years ago the company won a contract to supply a total of 600 pieces LG gas cookers and

washing machines to the employees of large public organizations. In order to part-finance the deal, the

company raised an import loan against trust receipts of GH¢120,000 repayable in 6 months. Although

the company was relatively new, your bank agreed to the deal.

There was a long delay in the arrival of the goods leading to the cancellation of the order. The customer

had no choice but to dispose off the goods on the market, an action which took a considerable period of

time. Meanwhile interest continued to accrue on the import loan leading to excess. In order to help the

company out of it difficulties the facility was extended for another period but the position continue to

deteriorate.

As the account relationship manager, you were particularly worried about the state of the account and

have invited the directors to a meeting. They inform you that steps are being taken to repay the loan but

that their efforts have been thwarted by the general lull in economic activity this year and the high

interest rates charged by the bank. In addition, the directors wanted to get your support in financing a

new lucrative deal in the pipeline. They have tendered for the supply of 100 pieces of LG split air-

conditioners to one of the United Nation agencies in Accra. They are confident of winning the contractand they claim, by their estimation, the profit on this deal net of expenses is about GH¢120,000. The

required support is GH¢400,000 at an interest rate of 25% payable within 3 years.

The only security you hold on this company whose outstanding debt as at today is GH¢80,000 is a

non–property debenture over the remaining stock of LG cookers and washing machines with a market

valuation of GH¢206,000.

Required: Assess the financial situation of the company using the following framework:

(i) Background of the company(ii) Financial analysis

(iii) Proposition

(iv) Repayment

(v) Collateral security

(vi) Decision/Recommendations


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Financial information of the company:

Lisa Company Limited

Statement of Financial Positionat December 2011 2012 2013

GH¢ GH¢ GH¢Current assets:

Debtors 150,000 170,000 230,000

Stock 135,000 190,000 257,000

Total current assets 285,000 360,000 487,000

Current liabilities:

Creditors 140,000 180,000 280,000

Hire purchase 2,000 2,000 2,000

Bank 90,000 105,000 138,000

Tax 8,000 10,000 5,000

Directors loans 10,000 10,000 10,000

Total current liabilities 250,000 307,000 435,000

Net current liabilities 35,000 53,000 52,000

Non-current assets:

Leasehold property 36,000 36,000 36,000

Fixtures and fittings 7,000 6,000 7,000

Motor vehicles 8,000 6,000 10,000Total fixed assets 51,000 48,000 53,000

Long-term HP 6,000 5,000 7,000

Net tangible assets 80,000 96,000 98,000

Share capital 20,000 20,000 20,000

P&L account 60,000 76,000 78,000

Shareholder’s funds 80,000 96,000 98,000


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Comprehensive Income Statement 2011 2012 2013

GH¢ GH¢ GH¢

Sales (2010: GH¢700,000) 900,000 1,050,000 1,300,000

Cost of goods sales 810,000 956,000 1,209,000

Gross profit 90,000 94,000 91,000 Administration & distribution expenses 57,000 59,000 78,000

Operating profit 33,000 34,500 13,000

Interest paid 8,000 8,500 11,000

Profit before tax 25,000 26,000 2,000

Tax 8,000 10,000 -----

Profit after tax 17,000 16,000 2,000

The electronic appliances industry average figures are as follows:

Gearing (%) 65

Current ratio 1.5

Acid test ratio 0.5

Cash ratio - 0.2

Debtors collection period (days) 75

Creditors payment period (days) 70

Stock turnover period (day) 65

Sales growth (%) 20

Gross profit margin (%) 8

Net profit margin (%) 1

Interests cover (times) 5


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Exercise [Corporate failure prediction model]

The trial balance of Desiree Limited as at December 31, 2013 is as follows:

GH¢ GH¢

Ordinary shares of GH¢1 each 18,000

10% Cumulative preference shares ofGH¢ each 5,000Income surplus as at January 1, 2013 20,350

30% loan from Stanbic Bank 3,950

Profit for 2013 22,400

Creditors 28,925

Investment income 70

Premises 36,000

Equipment 19,000

Investments 1,255

Stock 32,900

Debtors 7,400

Bank 2,140

98,695 98,695

Additional information:

(a) Profits accrue evenly throughout the year

(b) Provision is tobe made for:

(i) Tax amounting toGH¢3,500 payable on the current year’s profit.

(ii) Preference share dividend

(iii) Proposed ordinary dividend of 10%

(c) Sales for the year totalled GH¢105,000 of which 5,000 was VAT.(d) Market value of equity is GH¢5.25

Note: The industry benchmark for corporate stability has been fixed at 3.0 above which level

companies are regarded as safe from collapse in the short term. A score of 1.8 or below is a

signal for insolvency.

Required

As a financial analyst of your firm contracted by a Saudi millionaire who is interested in investing in

Desiree Limited, you are to advice on the going concern of DesireeLimited using Altman’s corporate

failure model.


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Exercise [Corporate failure prediction model]

Raja Limited is acompany engaged in the packaging of shear butter for export. Its financial statements

for the year ended 31st December, 2013 are detailed as follows:

Income statement for the year ended 31 December 2013GH¢ GH¢

Turnover 181,575

Cost of sales 157,500

Gross profit 24,075

Interest income 11,000

General expenses 20,750

Interest charges 6,000 26,750

Profit before tax 8,325

Taxation 4,165

Retained profit 4,160

Balanced sheet at 31st December 2013

Non-current assets: GH¢

Goodwill 15,000

Patent rights 5,200

Plant & equipment 92,500

Current assets:

Stocks 39,000Debtors 16,000

Prepayments 4,500

Bank 23,000

82,500

277,700

Financed by:

Ordinary shares (10,000 shares) 50,000

Capital surplus 15,625Income surplus 2,875

Liabilities:

Creditors 56,500

10% Debenture stock 152,700

277,700

Additional information:

The shares of the company are now selling on the GSE for GH¢1.10 per share.

Required: Using Altman’s prediction model, determine whether the company is in danger of collapse.


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Exercise [Common size analysis and computation of ratios]

The following data relates to Alpha Industries Limited.

Profit and loss Account for December 2010 2011 2012 2013

GH¢ GH¢ GH¢ GH¢

Sales 1,127,450 885,680 1,058,630 1,501,000

Cost of sales 689,710 544,780 632,140 710,820

Depreciation expense 28,740 31,110 35,490 38,900

Total cost of sales 718,450 575,890 667,630 749,720

Gross profit 409,000 309,800 391,000 751,280

Selling and distribution expense 149,710 111,660 151,080 288,000

Administration expense 50,000 52,000 57,000 63,000

Net operating profit 207,290 146,140 182,920 400,280

Interest income 6,300 3,730 3,890 4,200

Interest expense 32,340 33,920 24,350 33,280

Total other income (expense) (26,040) (30,190) (20,460) (29,080)

Profit before tax 181,250 115,950 162,460 371,200

Tax 68,250 53,620 75,990 86,420

Net profit after tax 113,000 62,330 86,470 284,780

Dividends payable 20,000 -------- 20,000 25,000

Retained earnings 93,000 62,330 66,470 259,780

Required: (i) Conduct a common size analysis and comment on the results

(ii) Compute the following ratios:

Profitability ratios

Liquidity ratios

Efficiency ratios

Solvency ratios

.

credit analysis and corporate failure prediction model case studies.pdf

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