A credit analyst generally analyses audited financial statements and recommends eligibility of loan. The analyst usually picks up figures from the statements without caring to understand, review and interpret statements precisely and recommends eligibility of availing loan. It is true that the analyst is not an auditor and hence, it is not his/her duty to audit. But it is his/her duty to assess the completeness and legal acceptability of the submitted financial statements and in doing so, the audited financial statements not acceptable legally must be rejected. How will he/she assess these financial statements and how will these be reviewed, analysed and interpreted?
STEP-1: COMPLETENESS AND ACCEPTABILITY: At first, the analyst will check whether the financial statements are complete, i.e., these contain all components of financial statements in accordance with the Bangladesh Accounting Standard-1 (BAS-1). Paragraph 10 of BAS 1 states the components of the financial statements as (i) Balance Sheet or Financial Position, (ii) Income Statement or Profit and Loss Account and Comprehensive Income Statement, (iii) Cash Flow Statement, (iv) Statement of Changes in Equity and (v) Significant accounting policies and notes to the accounts. Without these, the financial statements will be incomplete and the analyst must know it. On the other hand, according to section 189 of the Companies Act 1994, the financial statements must be signed by the directors, including managing director, and company secretary, if any. The signatory will vary depending on type of companies either private or public or banking companies or others. If the financial statements are not signed as above, these will be illegal documents. However, before undertaking analysis, the analyst should check such completeness and legality. Unless verified and satisfied on this, the board, the regulator and the court may question as to why the loan was sanctioned on incomplete and illegal financial statements.
STEP-2: RECOGNITION OF AUDITOR'S REPORT AND FINANCIAL STATEMENTS: If the financial statements are complete and legally acceptable under step-01, only then the analyst will undertake review of the auditor's report. Initially he/she will recognise the auditor's report and audited financial statements separately. Most of the analysts think that the whole set is auditor's report but this is not correct. The auditor's report is a report clearly titled as auditor's report generally on 1 or 2 pages placed over the balance sheet. Except this report, the whole contents from the balance sheet to the end are financial statements. The whole content should not be considered as auditor's report. In the financial statements, auditor cannot add any word or disclosure or statement. He may, however, suggest to disclose any fact, figure or statement as required by law or standard for better understanding in any place of the financial statements as the contents of financial statements. The management may accept and add those which will be termed as part of financial statements and will not be considered as output of auditor. In case of any material disagreement in presentation, the auditor will highlight it on the face of auditor's report. So whole contents will be two parts- (1) Auditor's Report (generally one or two pages or more over balance sheet), for which the auditor will be responsible and (2) financial statements (the whole contents from balance sheet), for which the management will be responsible.
STEP-3: ANALYSIS OF AUDITOR'S REPORT: Most of the analysts have very limited knowledge about interpretation of auditor's report and they do not take into consideration the opinion of auditor's report in due diligence process. The interpretation of the report is very important as it must be mentioned in due diligence memo presented to the approval authority. The auditor's report is template-based except the opinion paragraph. The template of the report is adopted by the Institute of Chartered Accountant of Bangladesh (ICAB) through the Bangladesh Standard on Auditing (BSA) in line with the International Standard on Auditing (ISA). The analyst must know that the opinion of auditor's reports are of four types--(a) unqualified, i.e., true and fair view of the financials, (b) qualified, i.e., the opinion stated as 'financial statements are true and fair except the notes stated below about disagreement or uncertainty' (c) adverse opinion, i.e., the financial statements do not show true and fair view because of having so pervasive nature of disagreement and uncertainty and (d) disclaimer of opinion, i.e., the auditor is unable to express opinion as to true and fair view of the financial statements. The memo presented to the approval authority must contain the type of opinion of auditors expressed with required explanation and information on behalf of recommendation. Only the unqualified report could be accepted unanimously by the approval authority as a green signal from the auditor as to true and fairness of the financial statements. For other types of opinion, the approval authority will review the explanation and information presented in the memo in lieu of recommendation.
STEP-4: ANALYSIS OF FINANCIAL STATEMENTS: Review, understanding and interpretation are the first jobs as a part of financial analysis. If any problem is found in accounting policy in respect of recognition, measurement and disclosures, the analyst could analyse the financial statements with those limitations stating before or after the result of analysis. Then the analysis could be done in three folds - (a) growth analysis for understanding the growth of assets, liabilities, income and expenses with a view to making query and getting clarification on abnormality, (b) ratio analysis for performance measurement of profitability, liquidity and solvency and (c) ratio analysis of cash flow statement. He/she may not know how to read and interpret the cash flow statement and as such, does not care about reviewing the cash flow statement and ratio analysis thereof. The income statement could present adequate profit but there may be cash crisis. Some ratio analyses on cash flow statement like operating cash flow ratio, current liability coverage ratio, earning quality ratio, cash flow per share, external financing index ratio and free cash flow etc. could give a good measurement of cash position of a company.
The analyst should visit client's office as well and review some of the figures with books or account as pointed out during growth analysis. This will ensure the degree of truthfulness of audited financial statements. As reviewer and lender, this is a significant part of due diligence process.
STEP-5: CONSIDERATION OF LIMITATIONS OF RATIO: The analyst should consider the limitation of ratio analysis as historical cost convention may not always be appropriate for the future, data used may not be updated. The ratio expresses the symptoms, not the cause of good or bad performance. It is difficult to consider any year as base year having no extraordinary impact and more information may be needed for any specific decision. In addition to that, the ratio analysis based on financial statements does not express the effect of change of price, technology and accounting policies. Good result of ratio analysis may have no value when the result comes under extraordinary scenario and may turn into bad due to change of price, technology or accounting policies. As such, the result should be reviewed to confirm whether it is under normal course of business and whether there is any impact of result of ratio due to change of price, technology and accounting policies.
STEP-6: RECOMMENDATIONS: Finally, the performance is assessed as Excellent, Good, Average and Poor. A poor performing company may also be selected if such bad performance was due to extraordinary adverse factors and it has adequate and appropriate causes to improve. However, the analyst must state reasons of recommending the credit approval with price (rate of interest) to be charged depending the risk of category of performance - excellent, good, average and poor.
There is no reason to believe that as the financial statements are audited, the analyst does not have any responsibility to confirm the completeness and legal validity of the financial statements. In question of fraudulent or manipulated financial statements, blaming auditor is a very common phenomenon. But blaming auditor is not a solution. The auditor may be held liable for signing such incomplete and illegal financial statements or he/she may not issue such report at all or the applicant may submit manipulated financial statements showing audited. Who knows what happened? The analyst will be held responsible for recommending a loan on fraudulent papers or illegal financial statements. But he/she will not be responsible for untrue financial statements but the auditor will be. In other words, it may be said that he/she will be held liable personally for failing to recognise the complete and legal set of financial statements as credit/money goes to wrong hands due to his/her negligence or lack of professional care.
The writer is an Associate Member of ICAB.