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Contingent Liabilities
Contingent liabilities are different for other debts. A contingent liability is one that depends on a possible event occurring before becoming an actual liability.
Assume you are the credit manager of a company supplying pipes on an open account to a company that drills water wells for individual homeowners in outlying areas. Your company has no direct contact with the homeowners involved. As part of your normal routine, you request, receive and review the drilling company's financial statements including balance sheet, income statement and cash flow statement regularly.
Unfortunately, one key piece of data is missing for your analysis, and it relates to an issue generally referred to as contingent liabilities. In this case, the drilling company has been accused of using unethical or illegal schemes to induce homeowners to agree to sign contracts for expensive water systems sold at inflated prices. As a result, the Attorney General has filed for relief on behalf of the homeowners against the drilling contractor, claiming price gouging, misrepresentation and other illegal business practices. If the Attorney General is successful, the contracts between the drilling contractor and the homeowners will be voided and your customer will be in serious financial trouble.
As a supplier, you were unaware of these issues. The traditional approach of reviewing the balance sheet, income statement and cash flow statement typically does not uncover issues involving contingent liabilities. Information about contingent liabilities appears in the notes or footnotes to a customer's financial disclosure to a creditor or potential creditor. The moral of the story is this: The more information you have, the better informed your credit decision will be.
© 2011 by Michael C. Dennis. All Rights Reserved