While the title suggested that it was a novice-level course, it wasn't just new credit professionals who tuned in to Doug Darrington, CCE's recent NACM teleconference, "Financial Statements for Beginners." Attendees of varying experience levels were rewarded with a wealth of thorough, practical information on how to best nail down a potential customer's financial health, a skill that has become vital in today's economy. "Financial statements form a basis for understanding the position of a business," said Darrington, a credit manager for Altaview Concrete, Inc. in Sandy, UT with more than 25 years experience. "Typically, you'll find the financial statements included in the annual report or, for any company that trades stock, it's required for them to submit an annual report to the SEC. For those who aren't large companies, we just have to take the financial statements that are provided."
In his presentation, Darrington went through what forms go into a financial statement as well as what each of them is worth in the analysis process. "Basic financial statements include a balance sheet, an income sheet, a statement of stockholder equity and a statement of cash flows," he said, diving head first into the balance sheet. "It's exactly what it says. It has to balance," he added. "It's made up of assets, things that the company owns, liabilities, things the company owes and stockholder's equity, also called net worth."
In terms of assets, Darrington first went through what comprises current assets and what else credit professionals can get from this and other figures. "Current assets include cash and those assets expected to be converted into cash within one year or one operating cycle, whatever's longer. Typically, the operating cycle will be shorter than one year. Therefore most financial statements will be presented at the end of the year," he said. "The working capital is simply the difference between total current assets and total current liabilities. That doesn't mean much all by itself but it will mean something in financial ratios."
One familiar portion of the financial statements that Darrington paused on was the potential customer's accounts receivable. "The accounts receivable is always the amount of money that is owed on credit sales, the amount that your customers owe," he said, adding that this figure will also be accompanied by another figure that indicates how much of the receivables are likely going to be collected. "This number is going to be net of doubtful accounts. Each company will have an account set up in various ways to allow for those items which they may not collect." How much of their receivables a potential customer is allowing for bad debt can be an important indicator of a company's fiscal health, and Darrington noted that comparing the current number with the prior year's figure is an important step in analysis. For example, if a potential customer has seen a sales increase over the last year and their allowance for debt that's not likely to be collected stays the same, this could be the sign of a good company that's made more cash sales. If there has been a decrease in sales and the allowance for debt that won't likely be collected stays the same, or goes up, this should be a red flag.
Darrington took attendees step-by-step through a sample financial statement and offered a number of important financial ratios that credit professionals can use to look deeper into a potential customer's health.
To learn more about NACM's teleconference series, or to register, click here.
Jacob Barron, NACM staff writer. Follow us on Twitter at http://twitter.com/NACM_National.