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Contingent Liabilities
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.

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