Analysis by Trial Balance-Part I

Even the most thorough analysis of a credit applicant's balance sheet and income statement is unlikely to answer every question about the applicant's financial condition. Often, a credit analyst can answer them by analyzing certain supplementary financial documents. One of the most useful of these is the applicant's most recent trial balance. This report may be exceptionally hard to get from a customer.

It has been stressed that it is important to base credit analysis on customers' most recent financial statements. In business, things can change with quickly. A good credit risk can become a poor one, or a poor risk can improve quickly. What has not been emphasized is that fact that a customer's "most recent" financial statement may not be especially current, and that the older the statements are the less reliable they are as a risk management and credit management tool.

The fact is that since statements are generally issued from two to four months after the close of the fiscal year, the statements that creditors receive typically contain information anywhere from two to fifteen months old. For this reason, it is often a good idea to supplement the analysis of a customer's financial statements with an analysis of its latest trial balance.

A trial balance is a schedule (usually drawn at the end of each month) of a business' assets and liabilities as of a given date, and of its income and expenses from the preceding balance sheet date to the trial balance date. The net worth figure or figures are not current but are carried over from the preceding balance sheet. The same applies to the inventory figure, unless the company is able to take an inventory at any time and not just when it closes its books.

As shown in the sample trial balance of the Wilcox Company shown below, all of these items are listed as either debits or credits. In the debit column are all assets and expenses; in the credit column are liabilities and income. From this schedule, an analyst can construct an interim balance sheet that will bring the company's financial statements current. Here is how to do it:

First set up in regular balance sheet form, all of the asset and liability items, except for those which were brought forward from December 31 of the preceding year (including the inventory and net worth figures):

Next, take the December 31 inventory figure and add it to the figures given in the trial balance for purchases, supplies, and wages:

Inventory (12/31/-)              $35,000 
Plus: Purchases -Materials     14,000 
                         -Supplies        2,000 
Plus: Wages                             7,000 
Total                                    $58,000 

From this total, subtract gross sales, less returns, allowances, and the estimated gross profit on sales. (The gross profit percentage can be obtained either from the customer's previous income statement or from your own knowledge of the line of business.):

Total Inventory, Purchases, and Wages               $58,000
Less: Gross Sales                                    $41,000  
   Deduct returns and allowances              1,000  
                                              Net Sales    $40,000  
Deduct estimated 20% gross profit             8,000 ______
Estimated Cost of Sales                            32,000

Next, subtract the estimated cost of sales figure from the total inventory, purchases, and wages to get an estimate of the inventory as of February 28 of the next year:

Total Inventory, Purchases, and Wages $58,000 
Estimated Cost of Sales                           32,000 
Estimated Inventory, 2/28/-                  $26,000

By inserting this estimated inventory into the proforma balance sheet, the analyst is able to determine the company's total assets figure ($79,000) as of the trial balance date. And, since the same figure must obviously appear for total liabilities, by subtracting from it the liabilities you have already listed, the net worth can be easily determined as shown here: ($79,000 - $34,000 = $45,000 net worth):

Edited by Michael C. Dennis.   Email questions or comments to:  mcdennis13@yahoo.com