Interpreting financial statements with ease 

When it comes to getting a thorough view of customers’ financial health, there are few resources as enlightening as their financial statements. While it may be intimidating at first to parse through the dense datasets, learning how to interpret and analyze financial statements can help credit managers make strong, swift credit decisions.

Why it matters: Gaining confidence in understanding financial statements can help credit managers thoroughly assess customers’ creditworthiness as they make credit decisions that best fit the needs and abilities of the customers. 

When reviewing a customer’s financial statements, credit managers will focus on three basic datasets: the balance sheet, income statement and statement of cash flows.  

The first—the balance sheet—lays out the company’s assets, liabilities and shareholders’ equity to communicate the overall value of the company. Scanning through a balance sheet and doing a few quick calculations can help credit managers get a sense of where the customer is before doing a deeper analysis. 

 “When I open the balance sheet, I start with what I call ‘cocktail napkin math,’” said Marc Greenberg, CCRA, credit supervisor for Mansfield Energy Corp. (Gainesville, GA) during the webinar Financial Statements for Non-Financial Readers. “I’ll take the assets and subtract the liabilities. If the sum is negative, I’ll go back and see how much they’ve got with goodwill and intangible assets. If you subtract the liabilities from assets and it’s positive, then you will feel at least reasonably comfortable as you start a deeper analysis into that customer.” 

The second dataset is the income statement, a report that shows their operational revenues and expenses over a period of time, often pulled quarterly or annually. “The income statement can tell you a company’s revenues, how well they performed in terms of their receipts and other related expenses,” Greenberg said.  

Looking at the income statement, credit managers can find the company’s gross margin by subtracting the cost of goods or services sold from the operating revenue. Often, businesses will calculate the cost of goods or services themselves on their financial statements, making it easier for credit managers to calculate the gross margin. If a company does not, credit managers will need to go through the listed expenses and subtract only the expenses that were necessary for the company to provide the product or service.  

“By looking at a company’s expenses, credit managers can get a strong sense of how the company is spending its money,” Greenberg said. “Did they spend more on salaries this year? Did they spend more in one area than they did the year before? You want to see if they’re operating themselves correctly in relation to the rise and fall of their revenue.” 

The third dataset, the statement of cash flows, is a report that shows how a company receives and spends its cash, reflecting how it operates using cash internally. 

Cash flow statements are split into three sections:  

• Operating activities: the cash flow generated by the company delivering goods or services, taking into account revenue and expenses. 
• Investing activities: relates to the cash flow generated by the buying and selling of assets. 
• Financing activities: details cash flow generated from debt and equity financing.

Reading datasets from top to bottom takes time, but as you become more comfortable reading financial data, red flags in a customer’s finances will start to stand out after your first readthrough of the data. “One of the first places I look is the cash flow statement,” Greenberg said. “If the cash flow from operating activities is in the negative, you’ve got a real problem with your customer, because that means that their core operations are not producing enough revenue to survive.” 

The bottom line: To interpret customers’ financial statements, credit professionals can learn how to pull the valuable information out of the larger datasets. Knowing what to look for and what formulas will reveal pertinent information can help credit managers approach financial statements with ease rather than anxiety.