Banks need to conduct a thorough financial and business viability analysis of its borrowers especially MSME NPL borrowers to determine their ability to repay their obligations. In addition, it is important to obtain sufficient insight into the business plan and projected cash flows available with the borrower for loan service. This will entail determining the borrower’s forecasted loan service capacity and assessment needs to be performed by the banks to align this with the restructured credit terms.
 

This analysis serves as the foundation for making an informed decision on the appropriate resolution approach – restructuring, sale to a third party, change of loan type (loan-to-asset or loan-to-equity swap) or legal proceedings. This analysis is required to be conducted by WU not previously involved in the loan approval process.
 

A. Analysis of key financial ratios
 

B. Balance sheet analysis
 

In addition to computing and analyzing the key ratios, the workout team should carefully review the balance sheet to develop a basic understanding of the composition of the borrower’s assets and liabilities. Primary emphasis should be placed on developing a complete understanding of all obligations outstanding to the bank and other creditors, including the purpose of the credits, their repayment terms, and current status, to determine the total debt burden of the borrower and the amount of loan that needs to be restructured.
 

The composition of liabilities, particularly “other liabilities" and accrued expense items should be addressed. Wages payable and taxes are two particularly problematic accounts. Both represent priority claims against the borrower's assets and must be settled if a successful restructuring or bankruptcy is to take place.
 

C. Cash flow analysis - defining financial viability
 

When financial statements are prepared on an accrual basis, cash flow analysis ties together the income statement and the balance sheet to provide a more complete picture of how cash (both sources and uses) flows through the company. Cash is the ultimate source of loan repayment.
 

The less cash is generated by operations, the less likely the borrower will be able to repay the loan, making it more likely that the bank will need to rely on its collateral (asset liquidation or bankruptcy) for repayment. Thus, the primary emphasis when conducting the financial analysis of the borrower should be on its forecasted cash generation capabilities. The proper analysis of cash flow involves the use of both the balance sheet and the income statement for two consecutive fiscal years to identify the sources and uses of cash within the company. Changes in working capital and fixed asset expenditures are quantified and cash needs are highlighted, providing a clear view of the many competing uses of cash within the company.
 

With respect to MSME borrowers, in case reliable and timely financial information is not available, cash flow based assessment is recommended. Banks should incorporate a robust and efficient internal process of cash flow estimation for these borrowers.
 

D. Business Plan
 

A comprehensive financial analysis of the non-performing borrower includes an assessment of the company’s business plan containing a detailed description of how the owners and management are going to correct existing problems. While no one can forecast the future with certainty, a candid discussion between the borrower and the bank on new business plan and financial projections is an essential part of the viability assessment exercise. It provides both the bank and the borrower an opportunity to explore how the company will operate under different scenarios and allows management to have a contingency (or corrective action) plans in place should actual results deviate significantly from the projections. The focus of the Workout Unit will be on validating the assumptions (whether realistically conservative and in line with past performance) and performing a sensitivity analysis to see how results will vary under changed assumptions. Again, the emphasis should be placed on tracing the flow of cash through the business to determine the company’s ability to pay.
 

E. Cash budget
 

Cash budget is a powerful tool, which helps the borrower to limit expenditures and preserve cash to meet upcoming obligations such as taxes. It can also compensate for the poor quality of formal financial statements in the case of micro and small enterprises.
 

In a workout, the ability to generate and preserve cash is the key to the company’s survival. All borrowers should be encouraged to prepare a short-term cash budget. The cash budget is similar to the cash flow analysis and differs, however, in two important respects: (i) it is forward-looking; and (ii) it breaks down the annual sources and uses by month to reveal the pattern of cash usage within the company. It also clearly identifies additional financing needs as well as the timing and amount of cash available for loan service. For smaller borrowers, a simple listing of monthly cash receipts and cash disbursements will suffice. Actual results need to be monitored monthly and corrective actions are taken immediately to ensure that the company remains on plan.