By Dean Kaplan+
When a credit department is considering a large credit limit for a potential new customer, financial statement analysis is critical to determining the credit worthiness of the customer as well minimizing the need for future debt collections. This is the third in a nine part series of articles about financial statement analysis. This article will discuss the reliability of financial statements.
Obviously, for the credit department to make sound credit decisions, the facts upon which the decision is made must be accurate and reliable. In general, there are four different types of financial statements: audited statements, compiled statements, reviewed statements and management prepared statements.
Audited financial statements represent the most reliable of financial statements because they are prepared by a Certified Public Accountant and reflect a very careful examination. Because the financial statements are prepared by a professional accountant, they come with a professional opinion, and therefore provide the credit analyst with the assurance that the financial statements were prepared accurately and reflect the true business picture. The CPA who prepared the statements is legally liable for the opinion which accompanies the financial statements, making the credit analyst very comfortable with the findings as they relate to the ultimate credit decision.
The CPA’s opinion is provided in the cover letter of the financial statements. There are four different levels of opinion, each with a differing level of responsibility taken on by the CPA:
Unqualified opinion — The CPA is willing to take the maximum level of responsibility for the financial statements. In this opinion, you will not see phrases such as “except for” or “subject to.” These phrases are a red flag that the opinion has qualifications.
Qualified opinion — The CPA is willing to take the maximum level of responsibility for the financial statements except for the points listed in the qualifications.
Disclaimer of opinion — The CPA is unable to render any opinion about the financial statements because of serious scope issues. In this scenario, the CPA does not take on any significant responsibility for the financial statements.
Adverse opinion — The CPA states that the financial statements are not acceptable because of noncompliance with Generally Accepted Accounting Procedures (GAAP).
It is not uncommon to be presented with unaudited financial statements from potential new customers. Oftentimes, a CPA will compile these financial statements for the customer, but will not offer any opinion about the statements. Unaudited financial statements prepared by a CPA fall into two categories.
Compilation — The CPA uses the client’s books and records to prepare the financial statements. The compilation does not include any analysis or verification of the accounting methods used in the client’s books and records. Therefore, the CPA takes no responsibility or liability for the financial statements.
Review — The CPA uses the client’s books and records to prepare the financial statements. The CPA performs some analysis and verification of the accounting methods used in the client’s books and records. The CPA offers a limited opinion that the accounting methods used by the client are in keeping with GAAP.
Sometimes the credit department may be presented with management prepared financial statements. This could happen for interim period analysis or if the company is privately held or very small. When faced with management prepared statements, be sure to utilize all the other components in the credit analysis such as the credit application, credit agency reports, banking information and trade references to reaffirm what is learned from the financial statements.
Once a potential new customer becomes a true customer, hopefully, the credit analysis including financial statement analysis gave the credit department a true picture of the customer. Sometimes, however, even customers who seemed credit worthy can run into tough times and end up with debt collections. When this happens, the financial and credit analysis data can still come in handy. When debt collectors become involved, the first step is to put together a debt collection file which includes all credit analysis information as well as unpaid invoices, contracts, etc. All of these data must be carefully examined before any contact is made with the debtor. Bringing a collection agency onboard to deal with delinquent customers can be an attractive option, especially if keeping the customer is a goal. Professional debt collectors can pursue debt collection using more aggressive methods because they are not involved in the ongoing relationship. The agency is a third party working on behalf of the credit department.
Click here if you are ready to move on to the next article in this nine part series Financial Statement Analysis And Debt Collections 4 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.