Looking For Risk in All the Wrong Places
Contingent Liabilities
By Steven Kozack

Credit professionals routinely request, receive and review financial statements from their larger customers. Typically, credit professionals will request a Balance Sheet, Income Statement and Cash Flow Statement. Unless the creditor also receives and reads the Notes to the Financial Statements, they are going to miss an important key to proper risk management - information about contingent liabilities.

What are contingent liabilities? A contingent liability is a potential claim against a company for which any actual or direct liability is dependent upon some future event or circumstance. Confused? Here are some alternative definitions:

• A potential obligation that arises from past events and whose existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within the company's control; or

• A present obligation that arises from past events but is not recognized because it is not certain that a transfer of assets will be required to settle the obligation; or the amount of the obligation cannot be measured with sufficient reliability.

• A liability that is difficult to quantify, or that may or may not come to pass.

Here is an example of a contingent liability. A lawsuit is filed against a company. The company does not list the amount demanded by the plaintiff as a liability because the company is uncertain as to the outcome of the case. Nevertheless, from the point of view of a credit professional evaluating the risk associated with extending credit to that company it is important to know:

• Whether or not the company has insurance that covers this type of contingent liability

• Whether or not the insurance will cover the entire amount if it determined that the company owes the claimant the entire amount

• When the question of the validity of the contingent liability is likely to be determined

What can credit professionals do to reduce the risks associated with contingent liabiities? Creditors should [a] always ask customers for Notes to the financial statements, and [b] should take the time to read these Notes carefully. If there are any questions or concerns, the creditor should ask for additional information about contingent liabilities.