Financial Statements

In a profit and loss statement, bad debts are recorded as an expense. They are typically included in the "depreciation and bad debt" or "allowance for bad debts" category. This category is a deduction from revenues to reflect the estimated amount of uncollectible debts.

Financial statement analysis is a tool most credit managers use in evaluating credit risk. Credit risk comes in two basic forms: 1. The risk that a customer's business will fail resulting in bad debt write offs for its creditors, and 2. The risk that the customer will pay slowly. However, many credit managers perform financial statement analysis without understanding its limitations. These are some of the limiting factors credit managers must keep in mind: * Past financial performance, good or bad, is not necessarily a good predictor of what will happen with a customer in the future. * The more out-of-date a customer's financial statements are, the less value they are to the credit department. * Without the notes to the financial statements, credit managers cannot get a clear picture of the scope of the credit risk they are considering. * Unless the customer financial statements are audited, there is no assurance they conform to generally accepted accounting principles. As a result, the statements may be misleading or even completely fraudulent. * To see the big picture, it is necessary to have at least three years of financial statements for comparison. Trends will only become apparent through comparative analysis. In performing liquidity analysis, most credit managers use the current and/or quick ratio. The problem is that these two ratios only provide an estimate of a customer's liquidity - they are not accurate enough to be used to predict whether or not a customer is capable of paying trade creditors and your company in particular - on time. Table 1 Hypothetical Customer Balance Sheet Cash $ 200 Accounts Payable $ 100 A/R $ 500 Current portion of long- Inventory $ 300 term debt $ 200 Total Current Assets $1,000 Current liabilities $ 300 Fixed Assets $1,000 Long-term debt $ 700 Total Assets $1,000 Equity $1,000

$2,000 Total debt + equity $2,000

Ratio Analysis Current ratio 3.33 to 1 Quick ratio 2.33 to 1 Debt to equity ratio 1.00 to 1

A "standard" evaluation of liquidity using the current ratio and the quick ratio would indicate the customer in Table 1 has strong liquidity. In reality, this may or may not be the case. For example:

If the current portion of the long term debt were due before the A/R can be converted into cash, this customer could have a cash flow problem and might be unable to pay trade creditors.

This information is not available through standard ratio or financial statement analysis.

However, our hypothetical customer may have already taken steps to address this short-term liquidity problem. The customer might have arranged for a loan to factor its receivables. Unfortunately, this type of information is also not available or apparent using normal financial ratio analysis. Therefore, credit managers must ask more questions and to understand the terms their customer is giving to its customers as well as the terms it receives from its suppliers.

Referring back to Table 1, traditional ratio analysis would also suggest that because our hypothetical company has debt-to-equity ratio of 1 to 1 and is not highly leveraged, that the customer is a relatively good credit risk. This is not necessarily the case. Consider this example:

Assume a formidable, well-financed competitor, with a superior product, has just entered the marketplace. The fact that your customer is not highly leveraged does not necessarily mean your customer will remain profitable and viable, assume your customer is embroiled in a lawsuit involving product liability claims, environmental cleanup issues, deceptive advertising, or securities fraud. These are contingent liabilities. Contingent liabilities do not appear on the balance sheet. The moral is that just because a customer has a strong balance sheet does not mean selling to this customer on an open account is low risk.

Referring back to the balance sheet in Table 1, let's assume your customer is the wholly owned subsidiary of another company. Suppose your customer's parent company is having financial difficulties, or is embroiled in a lawsuit involving large contingent liabilities. If the parent company decides to file for bankruptcy protection, in most cases its subsidiaries will also file at the same time. Again, traditional financial analysis does not give a clear picture of the risk involved in selling on an open account basis in this case.

Even if t

Another possible problem not defined or described in financial statement analysis is that the due date on bank debt can be accelerated if the debtor fails to meet a loan covenant. If we assume our hypothetical customer is out of covenant now, the risk of business failure and bad-debt losses is unrelated to the insights and information gained through financial statement analysis.

Here are a few ideas about financial statement analysis to keep in mind. As a customer's open account credit needs continue to grow, at some point it will become necessary to receive and evaluate a customer's financial statements to make an intelligent and informed decision about whether or not to extend the customer more open account credit. Once you have begun this process, be certain to request or require periodic updates.

The bigger your concern, the more frequently you should review a customer's financial statements. Pay particular attention to the nature and scope of the audit performed on a customer's financial statements.

Remember that internally prepared financial statements might not be worth the paper they're printed on. Be aware there is a limitation to comparing a customer's financial ratios to an industry norm. The limitation is the fact that industry norms are derived from companies willing or required to share financial information. Therefore, the best source of this information is publicly traded companies. So, if you're comparing a small, privately held customer's ratio to a public company's, the small company often suffers by comparison.

Keep in mind the fact that financial statement analysis is just one factor credit managers use to evaluate risk. Despite its limitations, this type of analysis has an important role in helping credit managers to gauge and control risk.

Michael C. Dennis, M.B.A. is director of credit and treasury services, Armor All Products Co., Aliso Viejo, Calif.

he parent company is not considering filing for bankruptcy protection, the parent company could require its subsidiaries to upstream cash to the detriment of the suppliers of the subsidiary.

Yes, buildings are typically included on a company's balance sheet as a long-term asset. They are recorded at their historical cost less any accumulated depreciation, and their value is listed under the "property, plant, and equipment" section.

Foreign currency translation is calculated by multiplying the foreign currency amount by the exchange rate. The exchange rate is the value of one currency in terms of another currency, and it can be obtained from financial markets or from central banks. The resulting product is the translated amount in the reporting currency.

An entry to transfer net income into owners' capital is done to account for the profits earned by the business and allocate them to the owner's equity. This ensures that the owner receives credit for their share of the earnings and reflects the increase in their ownership interest in the business. By transferring the net income into the owners' capital, it allows for the accurate representation of the overall financial position of the business.

A business may choose to use the revaluation model to measure Property, Plant, and Equipment (PPE) if it expects the fair value of its PPE to significantly differ from its carrying amount. By using the revaluation model, the business can adjust the carrying amount of its PPE to reflect its fair value and report a more accurate valuation on its financial statements. This can provide a clearer picture of the business's financial position and potentially enhance its financial performance.

Yes, inventories are included in total assets. Total assets refer to the sum of all current and non-current assets owned by a business or individual. Inventories, which consist of goods held by a company for sale in the ordinary course of business, are considered current assets and are therefore included in the calculation of total assets.

Fixed Asset Software, such as products developed by Sage, are designed to help one record and file data about solid assets within a business. Management software can help reduce mistakes such as redundant data entry as well as increasing regulatory compliance and managing depreciation. They can also create reports and help to effectively manage tax returns.

subtracting the current value from the previous value of the item. For example, to calculate the dollar change in net income, subtract the previous net income from the current net income. The dollar change is an important metric for analyzing the performance and trends of a company over time.

roughly $17.5 Billion, second globally to Soccer.

Depreciation expense represents the (systematic) decline in value of fixed tangible assets. The income statement (or P&L) shows the revenues and expenses of a company, including depreciation expense.

Yes, Accounting would be a service function. A service is any business that provides a well "service".

There are 2 main types of business, Merchandising, where a business sells a product, such as Wal-Mart, Target, a local resteraunt.

Service, where the company is in business to provide a service, Accounting, Dry Cleaning, Landscaping.

Since accounting would be the provision of an Accounting Service, then it would be a service business.

No.

Contribution Margin (CM) is the difference between the Sale Price and the Cost Of Goods Sold (COGS).

Cost of Goods Sold = Cost of parts, materials, labor to produce the item sold.

[This is also called Direct Cost.]

So, we can write a simple equation:

Contribution Margin = Sale Price - COGS.

If Sale Price goes down and COGS stays same, then Contribution Margin goes down.

-- 25 August, 2008

The exact number of businesses in the US that gross over 100 million a year is not readily available. However, it is estimated that there are around 37,000 large businesses in the US that generate more than $100 million in annual revenue. This number may vary and depends on factors such as industry, economic conditions, and other variables.

When allocating depreciation, the two accounts affected will be an expense account - depreciation and a negative asset/contra-asset - accumulated depreciation.

The journal entry would be:

Dr Depreciation xxxx

Cr Accumulated Depreciation xxxx

This effectively raises the expense and decreases your asset.

In the general ledger the depreciation account will be debited and the accumulated depreciation will be credited.

Ratios are used in accounting to provide a comparative analysis of financial data. They allow for easy interpretation and comparison of numbers across different time periods or between companies. Ratios also help identify trends, assess financial health, and identify areas of strength or weakness within a company. Overall, ratios provide a simplified way of conveying complex financial information.

Loan stock is considered a liability in a corporate balance sheet. This is because it represents borrowed funds that need to be repaid by the company to the lenders. It does not represent ownership or equity in the company.

Net profit is not shown on the liabilities side of the balance sheet. Net profit is shown on the income statement as a measure of a company's profitability over a specific period. The balance sheet, on the other hand, presents a company's financial position at a specific point in time, showing its assets, liabilities, and equity.

When long term liabilities are due after 12 months, then (part of) unearned revenue can be long term. This could be the case with long term contracts, such as maintenance, help-desk support, etc, where the fees for such services are paid up front for several years by the customer.

Premium on capital stock is neither an asset nor a liability. It is a component of shareholders' equity and represents the amount that exceeds the par value of the stock. It is typically recorded as a separate line item in the equity section of the balance sheet.

The capital expenditure would appear on the balance sheet of a company. It is typically listed under the category of "Property, Plant, and Equipment" or "Fixed Assets."

The provision expense ratio is calculated by dividing the provision for loan losses by the average total loans outstanding during a specific period. The formula is: Provision Expense Ratio = (Provision for Loan Losses / Average Total Loans) x 100.

i thought NO EFFECT on a DEBT TO EQUITY RATIO, since LongTerm Obligation or ShortTerm Obligation both are debts anyway. Neither increased, nor decreased the debts. So, the DEBT TO EQUITY remains unchanged. (I hope this is right)

Yes, a license can be considered an identifiable intangible asset. An identifiable intangible asset is a non-physical asset that can be separately identified and has a measurable value. A license grants the holder the right to use a specific intellectual property or resource, and it can be bought, sold, or transferred, thus meeting the criteria of an identifiable intangible asset.

Freight out is typically classified as a selling expense. It includes the cost of shipping goods to customers and is directly related to the sales process. Cost of goods sold, on the other hand, includes the direct production costs of goods sold, such as materials, labor, and overhead expenses.