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Myths and Misconceptions About
Financial Statement Analysis
By Michael C. Dennis, MBA, CBF

Myths and misconceptions about financial statement analysis abound. Credit department personnel have some misconceptions; customers and by salespeople have others. Some of the more common misconceptions include:

  • Myth: Financial statements analysis should be used to establish credit limits for customers. Reality: Financial statement analysis is part of a more comprehensive process of risk assessment.

  • Myth: Financial statements audited by a CPA that include an unqualified auditor's opinion should be considered totally reliable. Reality: If the Enron bankruptcy has reminded us of anything, it is that audited financial statements are not always totally reliable.

  • Myth: Requesting financial statements from privately held companies is asking for trouble. Reality: It is true that many privately held companies do not want to share their financial data with creditors. It is NOT true that a request for financial statements is always a problem. Requests of this type are routine.

  • Myth: Unaudited financial statements are better than nothing. Reality: Unaudited financial statements may be worse than nothing. They may include false and misleading information, they may not conform to accounting rules, or they may be entirely fraudulent. Unaudited financial statements should not be taken with a grain of salt - but rather with a bucket of salt since there is little chance the creditor will be able to independently confirm their accuracy.

  • Myth: Comparing individual customer performance to industry norms is a good way to benchmark customer performance. Reality: It is a way to measure performance, but industry norms are calculated using financial information provided to credit bureaus - but the ratios and industry norms provided as benchmarks may not actually be representative of the financial performance of the majority of companies or customers.

  • Myth: A customer with a current ratio if less than 2 to 1 is an accident waiting to happen. The customer is at serious risk of being unable to retire debts as they come due. Reality: Many companies operate successfully with tight current ratios - especially if these companies have made arrangements allowing the company to borrow short term to meet its current obligations.

  • Myth: A strong current ratio means the company under review is highly liquid and will pay debts as they mature. Reality: It is possible for a customer to have a strong current ratio, but be unable to pay creditors. It is a question of timing. If liabilities come due before assets can be converted into cash the company may be in trouble. Also, because a company has the ability or the cash to pay its creditors on time does not mean the customer will do so.

  • Myth: The quick ratio [or acid test ratio] is a good way to measure a customer's liquidity. Reality: The quick ratio is a more sensitive measure of liquidity than the current ratio. A strong quick ratio does not guarantee that a customer can and will pay creditors' bills as they come due.

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