Loan Repayment Sources

Loan repayment is the primary concern of a bank. As bank asset creation is backed by purchased debt of the deposit of depositors, therefore payback is important for the bank for income, reputation, and sustainability. To identify the repayment sources and capacity of the borrower, the credit department of the bank should use techniques of analysis of the business of the borrower. These techniques include; 

1.    Measure the ability of the borrower to pay i.e. financial statement analysis; three basic statements that tell the story as to how the business is performing financially. The balance sheet shows the company's financial position at a given point in time. An income Statement or Profit and loss indicates how much profit the company earned during a period of time. The cash flow statement tells how cash is generated during the period and where it has been used (cash inflow and cash outflow).

a.  Liquidity through; through Current ratio, Acid test Ratio, Working capital ratio.

Current Ratio = Current Assets divided by Current liabilities; this ratio indicates how sound the company is. How much dollar is available to pay each dollar of liability? The higher the ratio the better it is but not always and not everywhere.

Acid Test/ Quick Ratio= current assets less inventory divided by current liabilities; again this ratio indicates the health of the company in its most liquid state.

b.  Profitability Ratios; Gross Profit margin = Gross profit divided by net sales; It indicates much each dollar of revenue is gross profit. What %age of profit is included in revenues.

Operating Profit Margin= EBIT divided by sales; it indicates % age of operating expense in revenues.

c.   Efficiency Ratios;

ROE = Net income divided by paid-up capital plus reserves indicates the income rate earned on owner's investment.

ROCE = Net income divided by capital plus long-term debt showing how effectively the capital is being used.

ROA = Net income divided by total assets will indicate how well the investment has been made.

d.  Leverage Ratios; Interest coverage, Debt to Equity, and debt to total equity. 

Ratios alone do not give any meaningful results and guidance unless there is a benchmark for comparison. The result should be compared with industry standards or other companies of the same nature. 

2.       Repayment is ensured by;

a.   Cash flow; using techniques to ascertain the cash inflow and outflow of the borrower and identify the cushion for loan repayment.

b.  Asset conversion; Borrower balance sheet contains assets that can easily without loss be converted into cash to arrange for repayment.

c.  Refinancing from other banks/sources; Borrower has the ability to arrange finance from other banks for refinancing the loan or transferring the loan to other banks.