By Dean Kaplan+
Conducting a thorough financial statement analysis is an important step in any significant extension of credit and can prevent the need for future debt collections. The larger the credit amount requested by a new customer, the more thorough the financial statement analysis should be. This is the second in a nine part series of articles about financial statement analysis. This article will focus on an overview of financial statement analysis.
Once the credit department has examined a potential new customer’s credit application, bank statements, credit agency reports and trade references, an overall impression of the potential new customer should be possible. Does this look a customer the company would like to do business with? If the answer is yes, the final step in the credit analysis process is a careful look at the potential new customer’s financial statements for the past couple of years. Often the financial statements will confirm what you have gleaned from your credit analysis up to this point.
One of the benefits of financial statement analysis is that it enables the credit department to really hone in on the potential new customer’s sources of payment. Every company has four major sources of cash: net profits, converting an asset into cash, increasing liabilities, and increasing equity. A company must bring in more cash than it spends in order to be able to pay off any debt it may owe. In most cases, to make debt payments, which are considered short term liabilities, the source of the cash is from conversion of an asset into cash. Usually this is represented by selling inventory to create an accounts receivable, which will become cash in the short-term. This cash is usually what is used to make debt payments.
When the potential new customer provides the credit department with its financial statements, there will usually be two statements for each year submitted: the income statement and the balance sheet. When a company’s financial statements are prepared by a certified public accounts (CPA), the financial statements will be comprised of an opinion, an income statement, a balance sheet, a statement of retained earnings, a statement of cash flows, and any notes to the financial statements created by the CPA.
Collection agencies typically are not involved in credit or financial statement analyses. This does not in any way suggest, however, that collection agencies are not equipped to analyze and fully understand all financial statements. When a customer becomes delinquent in its payments, a company can either use its own internal debt collectors to perform its debt collections, or it may choose to hire a collection agency. Usually a collection agency is brought in when accounts receivable collections become an unmanageable problem. When a credit department turns over claims to a collection agency, the more information they provide the agency, the better job the agency will be able to do. Financial statements are an important part of the picture when assessing a debtor’s ability to pay. Accurate contact information coupled with a clear picture of a debtor’s financial strength or weakness will give the professional debt collector an advantage when debt payment negotiations begin. Even if a debtor cannot pay a debt in its entirety right away, often, payment terms can be reached which are satisfactory to both the debtor and the creditor. Frequently, accurate information is the key in this negotiation process.
Click here if you would like to go on to the next article in this nine part series Financial Statement Analysis And Debt Collections 3 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.