- 1. A deterioration in the customer’s cash position. This may be a drop in euro levels or in the percentage of total assets. It is often accompanies by marked changes in deposit activity inducing overdraft, draws on uncollected funds, more frequent and smaller depositing of checks and declining average monthly balances.
- 2. A slowdown in receivables collection period. Follow up on this symptom often reveals that the customer has become more liberal in its credit policies, has softened its collection policies or has become sloppy and neglectful.
- 3. Changes in credit and sales philosophies. Companies that have sold on regular terms suddenly have new classes of receivables. Installment sales replace stricter terms. Finance services may seem attractive, but most firms just do not belong in those businesses.
- 4. Sharp increases in the euro amounts of accounts receivable or the percentage of total assets. A receivables aging may well show substantial concentrations with a few customers - or worse, with a single customer.
- 5. Noticeably rising inventory levels both in euro amount or as a percentage of total assets. Jumps here are usually supported by trade suppliers - an extremely risky process. They may also be related to the borrower’s natural reluctance to liquidate excessive or obsolete goods at a reduced price. Too may businessmen sacrifice liquidity in an effort to maintain established gross profit margins.
- 6. A slowdown in inventory turnover. Follow up here may indicate over buying or some other impatience in the company’s purchasing policies. Often it indicates that it is frozen into some slow-moving items.
- 7. A decline in current assets as a percent of total assets. Short-term lenders rely upon the conversion of working assets as their normal source of repayment. As funds become increasingly concentrated in less liquid assets, the short-term creditors must look to a different class of assets to cushion their risk.
- 8. Falling concentrations in fixed assets. This can indicate funds needed to purchase fixed assets are being used for other operational purposes, these create problems in times of rising costs when replacement, renovation and remodeling pose possible serious drains on cash or cause a near-term need for large amounts of long-term debt.
- 9. Rising concentrations in fixed assets. This can be serious when achieved at the expense of other asset needs. Levels well above industry norms are an added indicator of potential trouble here.
- 10. Revaluation of assets for statement purposes. This is most commonly seen in the fixed asset area. It is justified to the extent it reflects more realistic values. It cannot be justified as an inducement to the lender to increase its loans.
- 11. The existence of heavy liened assets. The extent to which secured creditors have claims on various assets is a key to what may be left for general creditors. Evidence of second and third mortgage holders is a sign of greater than average risk.
- 12. Concentrations in non-current assets other than fixed assets. A common problem is the perpetual pouring of money by a parent company into affiliates or subsidiaries for which you can obtain no information or insight into the real value of those companies. .
- 13. A high concentration of assets in intangible values. The problems with intangible assets from the lender’s viewpoint lies in proper assessment of their value. Intangible assets shrink or vanish much faster and more extensively in liquidation than do hard assets. Remember that prudent credit analysis eliminates intangibles in computing a company’s net worth.
- 14. Disproportionate increases in current debt. The element of risk is always greater under the following conditions:
- a. The rise concentrated in trade debt.
- b. This rise is in “friendly debt” (monies due officers and/or stockholders) where there is no intent or willingness to subordinate the funds to other creditors.
- c. There is no corresponding increase in the levels of assets, current or otherwise.
- 15. Substantial increases in long-term debt. This is serious when repayment must depend upon a flow of funds, which would represent the bulk of anticipated earnings over many years..
- 16. A high debt to capital relationship. This is even more serious when the current ratio is low. Poorly capitalized companies will generally show poor working capital conditions. Even if there is adequate working capital, it generally is the result of heavy term funding. Future earnings, normally a source of working capital growth, might well have to be used exclusively for debt service.
- 17. A major gap between gross and net sales. This represents a rising level of returns and allowances, which could be caused by lower quality or inferior product lines.
- 18. Rising cost percentages. When it appears in the operating area, it may reflect a loss of control over a particular segment of general, selling or administrative expenses.
- 19. Rising sales and falling profits. The fall in profits may be in euros or in profit margins or in both. Unless the company is heavily capitalized, this circumstance will ultimately be reflected in an increasing reliance upon debt.
- 20. Rising levels of bad debt losses. Unless this remains constant as a percent of sales, it normally signals a deterioration in customer quality. It is usually accompanies by a slowdown in average collection period.
- 21. A rising level of total asset in relation to sales and profits. No one questions the fact that when you do more business you will normally require a higher level of inventory, carry greater receivable and probably need more fixed assets. The time to raise questions is when assets rise much faster than sales and profit growth warrant. .
- 22. Significant changes in the balance sheet structure. As an example, the disappearance of a large segment of fixed assets accompanied with new alignments of funded debt and unexplained capital adjustments may be evidence of a switch to sale and leaseback arrangements, unknown to creditors and missing from the statement notes.
The symptoms listed below are displayed by sound companies as well as potentially weak ones. However, if you put enough of these symptoms together, you may have a fairly good indication of near-term trouble. Financial figures often tell a story that will enable you to make a prudent and informed credit decision. In many cases, unfortunately, it takes considerable skill to understand what the figures really do say. The following comments provide some insight into many of the things a good analyst should look for in a review of any given set of statements.
(published in Linkedin)
Licenciado en Empresariales soy por lo tanto un empresologo...y he trabajado como morosologo, analista,...