As a merchant banker, identifying companies that need funds is crucial for helping them raise capital through QIP, debt, equity, or FPO. By analyzing financial statements and market conditions, you can pinpoint companies facing liquidity stress or expansion requirements. Here’s a detailed guide with key financial indicators, ratios, and external triggers to help you identify such opportunities.
1. Balance Sheet Indicators (Liquidity & Leverage)
These indicators highlight financial stress or the need for capital infusion.
Liquidity Ratios:
- Current Ratio = Current Assets / Current Liabilities
- Threshold: < 1.5 may indicate liquidity stress.
- Quick Ratio = (Current Assets – Inventory) / Current Liabilities
- Threshold: < 1 suggests liquidity issues.
- Cash Ratio = Cash & Cash Equivalents / Current Liabilities
- Threshold: < 0.5 suggests cash flow problems.
Leverage Ratios:
- Debt-to-Equity (D/E) Ratio = Total Debt / Shareholder’s Equity
- Threshold: > 2 is high, meaning the company is over-leveraged.
- Interest Coverage Ratio = EBIT / Interest Expense
- Threshold: < 2 means the company may struggle to pay interest.
- Debt Service Coverage Ratio (DSCR) = EBITDA / Total Debt Service
- Threshold: < 1.2 is risky, indicating potential default issues.
- Net Debt-to-EBITDA Ratio = (Total Debt – Cash) / EBITDA
- Threshold: > 3 suggests high leverage.
2. Profit & Loss (Income Statement) Indicators
These ratios help assess earnings stability and profitability.
Profitability Ratios:
- Gross Profit Margin = (Revenue – COGS) / Revenue
- Threshold: Falling margins suggest operational issues.
- EBITDA Margin = EBITDA / Revenue
- Threshold: Below industry average signals inefficiencies.
- Net Profit Margin = Net Profit / Revenue
- Threshold: Consistently < 5% can indicate financial stress.
- Return on Equity (ROE) = Net Income / Shareholder’s Equity
- Threshold: < 10% suggests poor capital utilization.
- Return on Assets (ROA) = Net Income / Total Assets
- Threshold: < 5% indicates inefficiency in asset utilization.
3. Cash Flow Statement Indicators
Cash flow health is a strong predictor of a company’s funding requirements.
Cash Flow Ratios:
- Operating Cash Flow (OCF) / Total Debt
- Threshold: < 20% indicates poor cash flow to service debt.
- Free Cash Flow (FCF) = OCF – Capital Expenditures
- Threshold: Negative for multiple years signals distress.
- CFO-to-Current Liabilities = Operating Cash Flow / Current Liabilities
- Threshold: < 1 suggests liquidity crunch.
4. Market & External Indicators
These qualitative signs provide further insights into a company’s financial health.
Market-Based Indicators:
- Stock Price Decline (> 30% in a Year) – Could indicate investor concern.
- High Promoter Pledge (%) – > 50% promoter holding pledged indicates stress.
- Low Institutional Holding (%) – Institutional exit might signal trouble.
Regulatory & Management Signals:
- Frequent Equity Dilution – Recurring FPO, QIP, or preferential issues.
- Credit Rating Downgrades – Suggests higher risk and funding challenges.
- Management Commentary – Earnings calls mentioning capital raise plans.
- Dividend Cuts – A company stopping dividends to conserve cash.
5. External Signs & Triggers
- Delayed Supplier Payments: Check trade payables and creditor turnover ratio.
- Rating Downgrades: A credit rating downgrade signals financial stress.
- Dividend Cuts or Suspension: Companies stopping dividends often do so to conserve cash.
- Recent or Upcoming Debt Maturities: Companies with large debt repayments may need refinancing.
Action Plan:
- Filter companies with high D/E (> 2) and low interest coverage (< 2).
- Check liquidity ratios (current & quick ratio) to confirm stress.
- Analyze cash flow trends – negative FCF and poor OCF to debt ratio.
- Look at market & external triggers like stock price declines, rating downgrades, and promoter pledges.
By systematically analyzing these indicators, you can shortlist companies that are potential candidates for fundraising through QIP, debt, equity, or FPO. Would you like a financial model template to automate this analysis? 🚀