Credit Analysis Worked Example

This worked example supports our credit analysis page, where you can explore the full process, key ratios, risk factors, and techniques used to assess creditworthiness.

A mid-sized manufacturing company requests a $20 million, five-year loan to expand production capacity. The credit analyst evaluates the company’s historical performance, proposed capital structure, cash flow, key business risks, and ability to continue servicing debt under less favorable conditions.

Area Evidence Credit implication
Performance Revenue increased from $85 million to $100 million over three years. EBITDA reached $12 million, with a stable 12% margin. Consistent growth and profitability support repayment capacity.
Leverage Total debt would rise from $20 million to $40 million after the loan. Debt-to-EBITDA would increase from 1.7× to 3.3×. The transaction would materially increase leverage and reduce financial flexibility.
Interest coverage EBIT is $9 million and annual interest expense is $3 million, producing interest coverage of 3.0×. Debt-service capacity is adequate, but the cushion against weaker earnings is limited.
Cash flow Operating cash flow is $10 million, while annual capital expenditure is $6 million. Positive operating cash flow supports repayment, but capital investment constrains free cash flow available for debt reduction.
Concentration risk The largest customer represents 30% of revenue. A customer loss or reduction in orders could materially weaken earnings and cash flow.
Downside case If EBITDA declined by 20%, debt-to-EBITDA would rise to approximately 4.2× and interest coverage would fall to 2.4×. The company could continue servicing its debt, but with a significantly narrower financial cushion.

Analytical Interpretation

The company is profitable and generates positive operating cash flow, but the proposed borrowing would materially increase leverage. Interest coverage remains adequate, although limited free cash flow and customer concentration reduce the company’s capacity to absorb weaker trading conditions. The downside case indicates that debt could still be serviced after a 20% decline in EBITDA, but with less headroom and greater refinancing risk.

Recommended Safeguards

  • The analyst may consider a lower initial facility or phased drawdown.
  • A maximum debt-to-EBITDA covenant of 3.5× would limit further leverage.
  • A minimum interest coverage covenant of 2.5× would protect debt-service capacity.
  • Restrictions on dividends and additional borrowing would help preserve cash.
  • Quarterly reporting and monitoring of customer concentration would support early identification of deterioration.

Credit Opinion and Recommendation

The analyst recommends conditional approval. The company has a sound operating record and adequate debt-service capacity, but the increase in leverage and customer concentration require covenant protection and ongoing monitoring.