By Michael C. Dennis, MBA, CBF
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, your customer (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 in your state has filed for
relief on behalf of the homeowners against the drilling contractor,
claiming price gouging, misrepresentation and other questionable 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 to the drilling company, you were unaware
of these issues. The traditional approach of reviewing only 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:
1. Credit Managers should demand full disclosure from their customers, including
access to notes to the financial statements.
2. Credit Managers who do not receive such notes are making credit decisions
without a full understanding of the risks involved in doing so.
Making credit decisions without all the information you
need can be harmful to your career as a Credit Manager.