Key Financial Statements and Credit Management Insights
Key Financial Statements
The four major financial statements are:
- Balance Sheet: Also known as the statement of financial position, it reports on a company’s assets, liabilities, and stockholders’ equity.
- Income Statement: Shows the profits and expenses over a period of time.
- Statement of Retained Earnings: Reports changes in retained earnings over a period.
- Statement of Cash Flow: Details changes in operating, investing, and financing activities.
Notes to Financial Statements
Notes are important to financial statements for security analysis:
- To develop estimates of the value of securities that the firm issues, influencing investor actions.
Current Rate Method
The current rate (translation) method is used to consolidate domestic and financial statements by using an exchange rate.
Different Viewpoints
Creditors, shareholders, and management may differ in calculating and interpreting financial ratios for monitoring a firm’s performance.
Financial Ratio Analysis
- Cross-sectional Analysis: Compares different firms’ financial ratios.
- Time Series Analysis: Evaluates a firm’s financial ratios over time.
- Benchmarking: A type of cross-sectional analysis that compares a firm’s financial ratios to those of its key competitors.
- Financial Leverage: The percentage change in net income for a percentage change in operating income.
- Debt Ratio: A measure of a company’s indebtedness.
- Coverage Ratios: Ratios that measure a firm’s ability to service its debt, such as times interest earned ratios and fixed-payment coverage ratios.
International Credit Management
Risk in International Credit
Risk in international credit management is more complex than with purely domestic sales because international operations typically expose a firm to exchange rate risk.
Credit Terms and Accounts Receivable
- If a firm’s regular credit terms conform to those of its industry, it may attract poor-quality customers who cannot pay under the standard industry terms.
- A firm should monitor the accounts receivable of its credit customers because a lengthening average collection period increases investment in accounts receivable.
- An aging schedule breaks down accounts receivable into groups based on the time of origin.
Cash Management
Float
Float refers to funds that have been sent by the payer but are not yet usable. It has three components: mail float, processing float, and clearing float.
- A firm should decrease collection float and increase payment float.
Cash Concentration
Three mechanisms of cash concentration are:
- Depository transfer check
- Automated clearing house transfer
- Wire transfer
- Zero-balance accounts are used to eliminate non-earning cash balances in accounts.
- A marketable security minimizes the time to convert the security into cash.
Short-Term Financing
Spontaneous Financing
Sources of spontaneous short-term financing include accounts payable and accruals.
- Accounts payable increase in response to an increase in sales.
- Accruals increase as wages and taxes increase.
Cash Discounts and Interest Rates
- There are no costs associated with a cash discount.
- Giving up a cash discount can be a source of additional profitability.
- The prime rate of interest for short-term bank borrowing is typically around 2%.
Types of Short-Term Loans
- Floating-rate loan: Interest rate varies with an increment above the prime rate until maturity.
- Single-payment note: A one-time loan made to a borrower.
- Line of credit: An agreement between a commercial bank and a business, similar to credit cards. It may include operating-change restrictions, a compensating balance, and an annual cleanup.
- Revolving credit agreement: A guaranteed line of credit for the bank, even if the bank lacks sufficient funds.
- Commitment fee: Charged on a revolving credit agreement, based on the average unused balance of the borrower’s credit line.
- Commercial paper: A form of short-term, unsecured promissory note issued by firms with high credit standing. Large firms often use this.
- Letter of credit: A letter from a bank confirming that a company has sufficient funds available.