There are three documents you should concern yourself with:
- The Trading Profit & Loss Account – deals with the past – Trading is all about buying & selling and the expenses associated with that activity. This document will show you how well the business is being run.
- The Balance Sheet – deals with the present – it presents a snap shot at a moment in time (the last day of the financial year) that details everything you own and everything you owe.
- The Cash Flow Statement - deals with the future - it shows the opening bank position, what cash is expected in and what expenditure is due to be paid and when. Accurate cash flow forecasting is easier to do than you may imagine and gives comfort to all when it is being delivered every month.
Some models use one or two of the above documents, I believe to give yourself an accurate picture you must use all three. When assessing the numbers avoid looking at each in absolute terms, if the answer is 31 and you ask is that good? I don’t know; it depends on the question! It also depends on where you were last month and the month before and it depends on how you are scoring in relation to others in your industry. So look at the numbers and more importantly look at the trends, are they getting better or are they getting worse?
In assessing financial information there are three main things I am looking for:
- Solvency – their ability to pay their bills as they fall due. The answer to this lies in the balance sheet – divide the total current assets by the total current liabilities if your answer is greater than one that is good news, if it is less than 1 that is bad news and could indicate they could have problems meeting their commitments as they fall due.
- Profitability – Is the business making money? The more profitable the business the greater its prospects irrespective of economic conditions. You will see the profit as the bottom line on the P&L account. One of the old indicators was concerned with growth – most businesses haven’t grown in the past two years so we need a new measure here.
- Efficiency – how well is the business being run, how old are their debtors? Have creditors been paid to terms? Is their stock holding policy correct? What about cash management?
There are also the four C’s to be taken into account namely:
Character: JP Morgan said “ I will do business with anyone as long as they are honest”
Capacity – Their ability to generate income
Capital – the overall value of the business
Conditions – in the market beyond the business
Bringing in credit professionals – people, who are trained, educated and practice excellent credit management, or taking your own staff to these levels is of vital importance in these more challenging times, to make sure you are making the right decisions that will bring the highest profits..
Sensible Credit Risk Assessment, is not about risk avoidance, nor is it about walking away from profitable business – it is about walking a fine line between risk and reward and delivering improved systems and procedures that fit these more challenging times.