#12: How to Analyse an NBFC: A Simple but Complete Framework

Let's start with something familiar.

A typical corporate P&L looks like this:

Revenue
Minus expenses
EBITDA
Minus depreciation
EBIT
Minus interest
PBT
Minus taxes
PAT

This structure works well for manufacturing or services businesses, where interest is a financing decision made after the core business has already generated operating profit.

But this framework does not explain a lending business.

Why an NBFC P&L looks different

In an NBFC, interest is not a financing afterthought. It is the raw material of the business.

An NBFC does not earn revenue first and then decide whether to borrow.
It borrows first. Without borrowing, there is no business.

So interest cannot sit "below the line" the way it does in other businesses.

That is why the P&L of an NBFC is structured very differently.

The core NBFC P&L structure

A clean, core NBFC P&L looks like this:

Interest income
Minus interest cost
Net Interest Income (NII)

Add fee income (for example, processing fees)
Net total income

Minus operating expenses
Pre-Provisioning Operating Profit (PPOP)

Minus credit cost
PBT

Minus taxes
PAT

For simplicity, we are ignoring non-core, one-off, or non-recurring items. Those matter, but only after you understand the core engine.

This structure tells you how the lending business actually works, not just how much profit is reported.

Why absolute numbers are misleading in lending

Looking at absolute profit numbers in isolation is rarely useful.

₹50 crore of profit could be:

• exceptional on a ₹500 crore AUM, or

• mediocre on a ₹5,000 crore AUM.

That is why lenders translate the entire P&L into percentages of average earning assets (average AUM).

This normalized view is commonly referred to as the ROA tree.

The ROA tree (an intuitive illustration)

An illustrative ROA tree looks like this:

• Interest income: 14%

• Interest cost: 8%

• Net interest margin: 6%

• Other income: +1%

• Total income: 7%

• Operating expenses: −2%

• PPOP: 5%

• Credit cost: −2%

• PBT: 3%

• Taxes: −1%

• PAT (ROA): 2%

Every number above is expressed as a percentage of average AUM.

So when we say interest income is 14%, we mean:

For every ₹100 of loans outstanding during the year, the lender earned ₹14 as interest.

Let's now read this table line by line, without assuming prior knowledge.

How to read the ROA tree (line by line)

Interest income – 14%

This is the yield earned on the loan book.

It immediately tells you something about:

• the borrower segment,

• ticket sizes,

• formality of income,

• and risk appetite.

Higher yields usually indicate riskier or more operationally intensive borrowers.
Lower yields usually indicate secured or wholesale lending.

At this stage, we are not judging whether 14% is good or bad.
We are simply establishing what the borrower pays.

Interest cost – 8% (a blended number)

This is where an important nuance comes in.

The 8% interest cost shown here is not the actual borrowing rate.

It is a blended cost, expressed as a percentage of AUM.

Why?

Because an NBFC does not fund 100% of its assets with debt.

Assume:

• Regulatory capital requirement: ~15%

• Equity: ₹15

• Debt: ₹85

• Total AUM: ₹100

If the NBFC borrows at, say, 9.5%, it pays interest only on ₹85:

Interest paid = 9.5% × 85 = ~₹8.1

When expressed as a percentage of total AUM (₹100), this shows up as ~8%.

So yes — equity is implicitly subsidising the cost of funds.

This subsidy is not an accounting trick.
It is the foundation of lending economics.

Net Interest Margin (NIM) – 6%

Interest income (14%) minus interest cost (8%) gives us 6% NIM.

This is the core spread earned by the NBFC for:

• borrowing money,

• taking credit risk,

• and intermediating between lenders and borrowers.

If NIM is structurally weak, no amount of fee income or growth can fix the business in the long run.

Other income – +1%

Next, we add recurring, predictable non-interest income.
In this example, we are assuming processing fees.

So now:

• ₹6 comes from interest spread,

• ₹1 comes from fees.

Total income becomes ₹7.

This line deserves caution.
One-off incomes such as portfolio sell-downs or direct assignments can temporarily inflate profits but do not reflect core strength.

Total income – 7%

This ₹7 per ₹100 of AUM is the entire revenue pool available to the lender.

From here onward, we are asking:

How much of this survives after running the organisation and absorbing losses?

Operating expenses – −2%

Operating expenses include:

• sales and sourcing,

• credit underwriting,

• operations and disbursement,

• collections,

• technology, admin, compliance, and support functions.

Subtracting ₹2 leaves us with ₹5.

Opex as a percentage of AUM is one of the most intuitive diagnostics in lending.

High opex usually indicates:

• low ticket size,

• high human involvement,

• field-heavy operations.

One subtle point: secured products often have higher opex than unsecured ones, due to legal checks, collateral valuation, and documentation.

Pre-Provisioning Operating Profit (PPOP) – 5%

PPOP is what remains before absorbing credit losses.

Think of this as the shock absorber.

A lender with healthy PPOP can survive bad years.
A lender with thin PPOP breaks quickly when asset quality turns.

Credit cost – −2%

Credit cost represents losses from bad loans.

A 2% credit cost means: Out of every ₹100 of loans, ₹2 is expected to be lost (or provided for).

More important than the absolute number is:

• consistency over time,

• behaviour across cycles,

• and alignment with yield.

Volatile credit cost is often a sign of aggressive or careless lending.

PBT, tax, and PAT (ROA)

After credit cost:

• ₹5 becomes ₹3 (PBT)

After tax:

• ₹3 becomes ₹2

This final 2% is ROA.

It means:

For every ₹100 of average loans outstanding, the lender earns ₹2 as net profit.

This is the most important profitability metric in lending.

From ROA to ROE

ROA tells you how good the business is.
ROE tells you how good the investment is.

ROE is driven by leverage:

ROE ≈ ROA × leverage

But in lending, leverage is not a free choice.

Why growth in lending is tied to net worth

RBI mandates minimum capital adequacy, broadly around 15%.

In simple terms:

• To build ₹100 of AUM, ₹15 must come from equity.

• The remaining ₹85 can come from debt.

So the maximum theoretical leverage is:

100 ÷ 15 = 6.67x

Meaning:

• ₹100 of equity can support up to ₹667 of AUM.

Prudent lenders operate at 4–5x.
Reckless lenders try to push the limit and are often stopped by debt providers before regulators intervene.

This is why, in lending, growth is constrained by capital, not demand.

Putting it all together

This framework helps you:

• understand the NBFC business model,

• compare lenders across sizes and products,

• see where profitability actually comes from,

• and judge how sustainable it is.

It does not replace deeper analysis of liquidity risk, ALM mismatches, or market risk, but it gives you a solid foundation.

Once you internalise the ROA tree and the role of equity, NBFC financials stop looking complicated and start looking almost mechanical.

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