By Dean Kaplan+
Financial statement analysis is an important element of credit analysis and can help prevent the need for debt collections down the road. Depending on the amount of credit a customer is requesting from a company, the financial statement analysis can be quite extensive. The higher the credit line, the more extensive the financial statement analysis process might be. This is the first of a nine part series of articles about using financial statement analysis to help make credit decisions for new customers. This article will summarize the typical credit analysis performed by the credit department before the financial statement analysis.
In general, several sources of information are used to determine the credit risk of a potential customer and the credit line to extend to the customer. These sources include the company’s credit application, credit agency reports, trade references and banking information. After completing these aspects of the credit analysis, the final step is financial statement analysis which will be discussed in future articles in this series.
The typical credit application which the company asks the potential customer to fill out collects a lot of information about the company including:
a. The company name and address.
b. The organizational structure of the company (i.e., corporation, partnership, or proprietorship).
c. The product lines sold by the business.
d. How the business operates.
e. How long the business has been in existence.
The credit agency reports are a good source of information about:
a. The owners of the business and their backgrounds.
b. The history of the company.
c. Whether or not the company is currently involved in any lawsuits
d. A summary of the company’s financial performance.
Using the above information, a credit department can usually get a pretty good idea of the potential customer’s credit needs and requirements. Analyzing these data can also provide the credit department with a basic understanding of how the potential customer’s business operates and how it would be to become a supplier to the customer.
Banking information is usually requested from potential customers as part of the credit application. When looking at banking information, the credit department should request information about the deposit as well as the line of credit relationships. Below is banking information that should be requested:
a. How long the potential customer has been a customer at the bank.
b. Deposit balances for all accounts (i.e., checking accounts, certificates of deposit, etc.).
c. The dollar amount of lines of credit.
d. The origination date for any loans.
e. The dollar amount currently available on lines of credit.
f. The expiration dates of any lines of credit.
g. Details of any restrictions assigned to loans or lines of credit.
h. Any violations relating to loans or lines of credit.
One important reason to carefully examine bank information is that these data provide a good indicator of a potential customer’s payment history as well as their ability to pay. Any loan violations are also very important signals. Banks can pull a line of credit due to a loan violation. If a line of credit is frozen, this can negatively impact a potential new customer’s ability to pay, making them a less than desirable credit risk.
Most credit applications request references from three or four of the potential customer’s current suppliers. These suppliers are usually asked to supply:
a. The dollar amount of the credit line extended to the potential customer.
b. How long the supplier has been doing business with the potential customer.
c. The dollar amount of the highest credit extended.
d. The current balance of the potential customer with the supplier.
e. A summary of the payment history of the potential customer.
The data collected from trade references should give the credit department a good idea of the credit worthiness of the potential new customer. If the potential customer has not had a good payment pattern with existing suppliers, chances are good that this will be the case with your company as well.
Collection agencies do not usually perform credit analyses. Credit departments are usually where credit analyses occur as they attempt to determine the credit risk of a potential new customer. The more effort put into credit analyses, the less likely there will be a need for debt collections in the future. When a credit department has an accurate understanding of a potential new customer, the correct amount of credit will be extended to them. When a customer runs into difficulties, this is when debt collections become a reality. At this point, internal debt collectors can begin to work to collect the past due invoices, or the credit department can hire a collection agency. No matter who attempts to collect the delinquent monies, the information collected in the credit analysis will be valuable because it will provide the debt collector with the correct contact information as well as other information that may be useful in negotiations. Time spent doing an in-depth credit analysis is rarely time wasted.
Click here if you are ready to go onto the next article in this nine part series Financial Statement Analysis And Debt Collections 2 of 9.
And be sure to check out the rest of the articles in this series:
- Credit Analysis
- Financial Statement Analysis
- Financial Statement Reliability
- Credit Investigation Levels
- Net Income Analysis
- Financial Strength of a Potential Customer
- Liquidity Position of a Potential Customer
- Cash Flow of a Potential Customer
- Operating Cycle of a Potential Customer
The Kaplan Group is a boutique collection agency specializing in large (over $10,000) debt collections due from businesses. Founded in 1991, the company has a stellar reputation (A+ rating with the Better Business Bureau) and is recognized as one of the leading collection agencies for results on large and complex matters.