Myths About Financial Statement Analysis

1. Myth: Financial analysis stands alone in its ability to evaluate risk and assign appropriate credit limits and terms.

Reality: Customer financial statement analysis is one tool in the credit department's toolbox that can be used to measure risk and help control aging and delinquencies.

2. Myth: Asking for a financial statement is asking for trouble.

Reality: Creditors may not always get financial statements from privately held companies, but doing so is becoming a routine part of the interaction between applicant and credit grantor.

3. Myth: Credit reporting agency reports do a good job reporting on customers' financial statements.

Reality: Statements are often out of date. Credit reporting agencies tend to truncate (shorten) the information received. Agencies do not normally provide the Statement of Cash Flows, or Notes as part of their analysis.

4. Myth: Financial statements should be compared to industry norms to give credit managers a benchmark.

Reality: Industry norms are often unrepresentative of the "normal" performance of the majority of companies in an industry. The flaw lies in the way data is collected.

5. Myth: The choice of method of depreciation is a minor detail of little concern to the credit manager.

Reality: All of the accounting conventions adopted by the debtor are important in learning about the customer or applicant's financial stresses.

6. Myth: Foreign financial statements easy to get and easy to understand.

Reality: In some countries, trade creditors are almost never given financial statements. Foreign financial statements are hard to interpret because they:

• Are not denominated in US dollars
  
• Are not formatted in the same way as US financial statements
  
• Classify accounts differently
  
• Do not follow GAAP
  
• May have little or nothing in common with the customer's true financial condition
  
• Say nothing about the customer's ability to get payments out of the country and into the account of the foreign seller.