Tips for Understanding your Customer's Bank Credit
By Cindy Moorhead
Moorhead Management Services
A bank credit line (also called a revolving credit
facility) is a working capital loan. Your customer may have, for
example, a $10 million line of credit with their bank. This means
they have the ability to borrow up to $10 million and, up to that
amount, may increase or decrease their borrowing on a daily basis.
The amount borrowed under the bank credit line is included when calculating
most leverage ratios.
When analyzing your customer's financial statement,
it is important to understand how close the company is to reaching
their maximum borrowing under the bank credit line. Also, looking
at trends will help understand if, over a period of time, they are
increasing or decreasing the overall borrowing.
Seasonal fluctuations go hand in hand with credit
lines. It is typical to see the highest credit lines just before
and during the busy season when a company builds inventory but has
not yet collected the sales from the busy season.
However, if it is not the busy time of year and you
see the customer being close to the total available on the line of
credit, a red flag should go up. The balance sheet will show the
amount borrowed. The total amount they can borrow under the bank
credit line (called the availability) will probably be noted in the
footnotes or management discussion. If your customer has borrowed
their maximum in the nonbusy season and will not have additional
availability on the credit line when they need it, be aware they
may stretch their payments to you to fulfill their working capital
Even though a company may always have a certain level
borrowed, in theory, a credit line is borrowed and repaid each day.
Therefore, a credit line is usually shown in the current liability
section of the balance sheet.
From time to time you may receive a financial statement
that has the credit line in the long-term section of the balance
sheet. They justify the long-term classification as always having
a certain amount borrowed that would not be paid down in the next
twelve months. If I find the bank credit line in the long-term liability
portion of the balance sheet, I move it into current liabilities
for analysis purposes (particularly when calculating the current
and quick ratios). The reason for this is that industry standards
for these ratios generally have statements with the bank line of
credit in the current liability section.
If you do not move it from non-current liabilities
into current liabilities for analysis purposes, the company's liquidity
will look better than other companies in a similar situation. In
fact, sometimes it will look real good when there may be liquidity
problems that will be hidden because the bank line of credit is shown
as a non-current liability. Classifying a credit line as a long-term
liability is one way a company may try to make their statements look
Another thing to look at with the bank line of credit
(and other borrowings as well) is the interest rate on the debt.
If the borrowing rate is close to the prime rate, I assume this working
capital loan is a standard risk for the bank. A red flag goes up
if the rate is well above prime. Borrowing at a high interest rate
means the company is considered a risky loan to their bank.
Many times you will receive financial statements without
footnotes or management discussions. In these cases, the bank credit
line is an excellent discussion point to use when you call your customer
to discuss their financials. Asking questions about their banking
situation can help open up communication on finding out what is really
going on in their company. Discussing your customer's financials
also lets them know you are analyzing the statements!
Cindy Moorhead is a CPA and founder of Moorhead
Management services. She speciaizes in financial statement analysis
for credit professionals. Her e-mail is firstname.lastname@example.org
Reprinted by permission from Trade Vendor Quarterly
Blakeley & Blakeley
LLP Spring 01