In this video, Faculty trainer Elena Pellegrini walks through the fundamentals of corporate credit analysis—what creditworthiness means and how analysts assess a company’s ability to repay debt over a given time horizon. She highlights how qualitative factors like management credibility and business strategy combine with quantitative review of financial statements to form a complete picture. With examples she explore what factors can effect a company’s credit worthiness and why analysis is more than just the numbers.

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Credit analysis is the process that evaluates a company’s creditworthiness.

When we say creditworthiness, we mean the ability of a company to repay debt in a determined time horizon. So for instance, imagine of yourself as a relationship manager or a credit analyst of a bank that has to consider whether to extend a loan to a new company he doesn’t know much about. Well, obviously the first thing you really want to understand and know is to ensure that this company has the financial stability and future prospects to repay the loan.

To do this there are some key analyses that are both qualitative and quantitative that must be taken and they should be combined together so that the analysis doesn’t end with itself but it can actually help to take a reasoned decision and an informed lending decision.

One of the first steps you should actually focus on is understanding and evaluating the credibility of the management team, the leadership, who is running the company, why are they running it, what’s their background, what what’s their credibility and who are the shareholders.

Why is this important? Well, this is important because it’s more likely that a company with a strong leadership team can actually run a company and help the company during a difficult period or even a crisis period rather than a company with a lower management profile like a startup with very young managers with little experience. So you want to consider all of this in your analysis and this is one of the first qualitative, very important analyses that you have to take.

Second, I would say that you should understand the business strategy. What’s the company’s financial position in the market? What’s their operational efficiency? For example, if a company is aggressively expanding in the market, going and discovering a new segment, launching new products and so on, you understand that this obviously can affect the company structure and its financial health. And it’s very important for analysts to understand this. For example. You have a retail company that keeps on opening stores very fast and so the first thing you will see is actually a boost on their revenues and you say wow this company is doing really well, it is growing very fast. But you should be careful at existing stores, because a company can’t rely just on the newness factor.

So if you take for example, a peer of this company, a competitor that has a less dramatic growth and management (so you see the combination between two elements of analysis  – the management I was talking about before)  say that this company has a slower growth, focuses on these existing stores, it improves them, it invests in them and well guess what? Probably in the long term this company will have a better stability and will have more consistent financial results even if the revenues at first are impacted, you will see a stable growth and a stable trend.

This example highlights that an effective credit analysis goes beyond just crunching numbers. A good analyst must understand the story behind the numbers. You have to have the big picture to understand the financial health and the potential risks that a company can face.

Linked to this there’s obviously the macro analysis, the market condition and the overall economic factors. We now live in a world where this has a real major impact. I don’t want to talk about what’s actually happening right now because the effect of all of this will actually be understood in the company’s numbers in a couple of months. But I want to make an example a recent one.

Think about 2022 when the Ukraine and Russia war started. What impact has this had on companies because the oil price surge and supply chain disruption? So all of this had an impact and an effect also on very well established companies. So, think about American Airlines for example. So probably this company will struggle and have to face a big challenge.

Or think about even Covid when big retail chain companies like Zara or Macy’s when all the shops had to close down and the consumer behavior changed. They actually had to face, very quickly, a new business strategy and they had to consider the macro sector around them and those who weren’t ready to do that struggled and some of them had to call bankruptcy. So this is how much all these factors can impact a company structure.

Obviously analyzing financial statements is crucial. Understanding the balance sheet, the cash flow, the income statement because it gives you a snapshot of the company’s financial health in the specific moment and it allows you to be able to do some evaluation about how can this evolve in the near future to understand its stability and profitability.

For instance, analyzing the cash flow can uncover liquidity issues despite a good level of revenues of a company. Understanding a balance sheet might reveal some high debt levels. It can highlight a potential insolvency risk, so if the company takes another loan the company might struggle to repay that because its financial structure may become too heavy.

So all of this all of this analysis I’m talking about will actually bring us to the purpose of this analysis which is actually assessing the risk that can impact the bit of repaying the debts or it can help you in making informed investment decision. It can set appropriate credit limits. It can help support strategic planning and obviously one of the most important things is that it helps understanding that key analysis must be monitored over time. It doesn’t end with the first screening. You have to keep on monitoring because everything, as you can understand, can change very, very fast.