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Limitations of Financial Statements
Problem with benchmarks
Problem with benchmark
Many firms have product lines that span a range of industries.
The diversity of products makes it hard to develop suitable benchmarks against which to evaluate firm performance.
Average ratios for firms within the industry may be available, but not the dispersion thereof.
This makes the use of benchmarks less reliable and less useful.
Actions taken or not taken prior to issuing financialstatements in order to improve the appearance of the financial statements.
Ratios are calculated using historical financial statements.
Unless the figures in the financial statements are marked to market, it is hard to obtain a true picture.
Further, the lender is interested in obtaining a futuristic view and it may not be correct to predict the future on past trends alone.
Ignores qualitative aspects such as the quality of management, regulatory changes and changes in the domestic and international economies.
Borrowing Reasons/Causes for Farmers
Long term finance - Acquisition of land
Medium term - Especially for equipment purchase
Short term - utilised on a seasonal basis
Risks in lending to farmers
Key man risk
3 Basic Principles that guide lending decisions
Safety of loan
Suitability of loan
International trade risk
Foreign Exchange risk
Cash Flow Analysis questions
Will the expected cash receipts of a business be adequate to meet all the required payments including loan repayments?
Has the business the financial flexibility to survive a period of adversity if the expected cash flow does not occur.
Altman's Z Score
Altman used multi discriminant analysis to distinguish between two population i.e. good borrowers and bad borrowers.
A score is constructed using accounting ratios, then this score is measured against the benchmark.
Credit worthiness means whether the prospective borrowers is worthy of receiving requested credit (finance).
Assessed by 5 C's approach