What is Loan Analysis?
Loan analysis is an evaluation method that determines if loans are made on feasible terms and if potential borrowers can and are willing to pay back the loan. It checks the eligibility of the potential borrower against the criteria set forth for lending.
Loan analysis gives the creditor a measure of safety on the loan by determining the probability that the borrower will pay back the loan (principal and interest). Follow-up visits to the potential borrower, especially for individual loans, help the lending institution gauge the performance of the investments or assets that are intended to generate revenues to help settle the loans.
- Loan analysis is an evaluation method that determines if loans are made on feasible terms and if potential borrowers can and are willing to pay back the loan.
- It checks the eligibility of the potential borrower against the criteria set forth for lending.
- Loan analysis helps in assessing the skills and financial knowledge of the borrower to determine the level of risk involved.
Lenders work under governmental financial regulatory bodies, which provide various regulatory guidelines to guide the operations of the institutions. Every institution, however, follows its own internal guidelines in line with the regulatory guidelines imposed by the government or its agencies. Loan guidelines include eligibility rules, type of loans to be provided, conditions on loans, loan security, and procedures.
Not everyone is eligible for a loan unless they meet the lending criteria provided by the specific lending institution. When conducting a loan analysis on a potential client, lending institutions analyze the financial statements of the client to determine their financial capability and their ability to honor the loan obligations without strain.
Lenders can offer either long-term or short-term loans. Long-term loans come with a longer repayment period, and borrowers are required to repay the loan within a period exceeding one year. Short-term loans offer a shorter repayment duration than long-term loans, and borrowers should repay the loan within a few months to under one year.
The lending guidelines are specific to a lending institution and can be based on the maximum and minimum loan offers extended by the lender, associated fees, late-payment penalties, schedules, interest rates payable, and amount of loan based on the collateral provided. The guidelines also outline loan security measures and procedures laid out by the institution. Loan procedures may include disbursement steps, loan application guidelines, loan collection guidelines, loan supervision, loan approval, and review procedures.
Loan Application and Loan Analysis
A loan application is an entire process starting from the negotiation of terms until the loan is reviewed and approved for disbursement. A loan application form is first provided to the client, and the client is required to fill it out correctly before the application form proceeds to the review stage. The client must provide truthful information, including their personal details, physical address, financial statements, evidence of asset ownership, etc. The information should be verifiable, and the credit officer should verify the accuracy and truthfulness of the information provided in the application document.
Providing accurate and correct information helps the company in tracking the loan repayments through elaborate measures provided for loan security. The information is used in the initial loan analysis and assessment to determine the risk involved, adequacy of the collateral provided, and the borrower’s ability to make repayments in time. In case of default, the lender uses the information provided to make follow-up and force repayment.
The Balance Sheet and Loan Analysis
The balance sheet (statement of financial position) is a crucial loan analysis tool. It shows the status of both the current and fixed assets of a potential borrower. The status of the current assets assists loan analysts in determining how much the entity can comfortably absorb and still settle the debt in time. The assets can also be used as loan security, and if it is adequate, the lender can comfortably approve and disburse the amount of loan that’s been requested by the client.
The balance sheet also shows the movement of inventory and cash flows, which are important in assessing the financial strength of the client. It also shows the financial transactions of the business for a period of one year, and it can be compared to the previous year’s balance sheets to determine if the business is on an upward or downward trend. Credit analysts can use the balance sheet to generate financial ratios that the lender can use to generate key performance measurements.
Profit and Loss Statement for Loan Analysis
The profit and loss statement (statement of financial performance) complements loan analysis in a variety of ways. The current revenues can be used to predict the financial performance of the company in the near future. The P&L Statement also indicates the potential impact of the loan amount on the business. It enables the loan analysts to determine the extent to which the loan can benefit the entity and to what extent the loan can be damaging to the business.
Other Loan Analysis Tools
Other tools that complement loan analysis include a business plan and repayment schedule. A business plan enables the client to set achievable objectives and can form the basis on which the creditor can follow the progress of the business. A repayment schedule aids in tracking repayments of the principal and interest and the duration within which the client will finish repaying the loan.
CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below: