Don't Rely Too Heavily On Financial Statement Analysis to Manage Credit Risk
By Michael C. Dennis, MBA,
credit managers rely too heavily on financial statement analysis
without understanding its limitations. If the recent accounting scandals
have demonstrated anything, it is that financial statements are subject
to various forms of manipulation - some of it allowable and some
of it improper and possibly illegal. Here are some of the limitations
of financial statements:
A customer's past financial performance - good
or bad - is not a perfect indicator of future performance.
The more out-of-date financial statements are,
the less valuable they become to the credit department.
In some instances, unaudited financial statements
are worse than nothing - because they can be entirely fictitious
and intended to be used to defraud creditors.
More broadly, it is impossible to know how accurate
unaudited financial statements are. For this reason, it is
imprudent to rely too heavily on them when evaluating credit
Unless a customer or applicant provides a prior
period financial statement for comparison, there is no starting
point from which to determine whether or not the risk of offering
open account terms to the company under review is getting larger
Most creditors do not receive copies of notes
to the financial statements except from publicly traded companies...but
without these notes it is impossible to get a clear picture
of the company's financial health.