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Limitations of Financial Statement Analysis
There are any number of limitations to financial statement analysis. For example:
- The Balance Sheet presents the relationship between assets and liabilities on a specific dayin the past.
- An Income Statement or the Statement of Cash Flows reflects performance over a specified period of time.
- Credit professionals analyzing the financial statements must remember significant changes can impact a company's financial standing after the financial information ispublished. Examples can include death of an officer, loss of a major customer, expiration of a patent. On the positive side, examples can include loss of a major competitor, success of a recent product innovation, infusion of additional capital, or the hiring of a very talented employee.
- inancial perfomance (good or bad) is not a perfect indicator of future performance.
- The more out of date a customer's financial statements are, the less valuable they are in evaluating credit risk.
- Unaudited financial statements may contain two types of errors: (1) unintentional mistakes, or (2) intentionally fraudulent statements.
- Unless a customer provides prior period financial statements for comparison, there is no starting point that can be used for comparison.
- Notes to the financial statements contain information not found anywhere. Without them, but most creditors do not request or receive these notes.
- Fixed assets are shown on the balance sheet at their acquisition cost minus accumulated depreciation. The fair market value of these assets is always different from the book value.
- No open account sale is guaranteed.
- Problems in the debtor company can create unexpected problems for the debtor and its creditors.
- Audited financial statements are not always accurate
- Creditors often have limited or no visibility to their customers' off balance sheet financing
- Financial statements do not tell you about the loss of a major customer by your customer.
- Foreign financial statements usually do not follow GAAP.
- Financial statements do not tell you about troublesome changes in the competitive environment in which your the debtor company operates.
Edited by Michael C. Dennis. Michael is the author of "Credit and Collection Handbook." He can be reached by email at mcdennis13@yahoo.com