Are financial statements still valuable?

The short answer is yes, the credit community can still find value in financial statements. But we may need to reconsider the way in which we think about financials.

The value of annual financial statements is being challenged by today’s fast-paced world, where business decisions are made at lightning speed. While these documents have long served as the bedrock of financial analysis and decision-making, their relevance is diminishing. The inherent lag in financial reporting means that by the time statements are prepared and distributed, the information they contain can be outdated.

Why it matters: While financial statements remain valuable in certain situations, credit managers should explore alternative approaches that can provide real-time insights.

Financial statements are reports showing the financial activities and performance of a business. The four major types of financials include:

1. Income statements show net income or net loss, tracking all money coming in and out of a business. Money paid out is referred to as expenses, while money coming in is revenue.
2. Balance sheets contain assets, liabilities and shareholders’ equity. The assets in balance sheets include cash, inventory or anything else owned by the company. Liabilities typically include accounts payable.
3. Statements of cash flow show you where the cash went. Larger companies can have up to three categories (operation, investment and financing activity), whereas smaller companies use two main categories: cash inflows and cash outflows.
4. Statements of owner equity show any changes in the owner’s equity between accounting periods.

Whether a customer is long-term or brand new, it is essential to stay abreast of their credit history. Evaluating the health of the business through payment patterns and other proofs of funds are great ways to mitigate risk. Kevin Stinner, CCE, CCRA, credit manager at J.R. Simplot Company (Loveland, CO), said he requests financial statements only after certain credit limit requests. “If it’s a lower credit limit request, we may only require partial financial statements or may not even require them at all,” he said. “Financials are advantageous in the sense that you get a chance to take a deeper dive into the customer’s financial stability, not only the equity but also the short-term liquidity of the customer.”

By the numbers: Despite some benefits, 16% of credit managers never request financial statements from customers, according to a recent eNews poll. 62% request financials sometimes and only 21% say they always request financials. This is likely due to some of the pushback credit professionals receive from customers.

Publicly traded company information is usually available to the public eye. However, private companies may operate a bit differently. Confidentiality is a big concern, so it is essential to reassure security when requesting any financial documentation. “Private companies tend to keep their information private, but if they are against sharing financial statements, we will supply a non-disclosure agreement (NDA),” said Scott Chase, CCE, CICP, global director of credit at Gibson Brands, Inc. (Nashville, TN). “Credit people by nature recognize the information they obtain should be held in confidence so offering NDAs usually helps. But some customers will still say no, either because their company doesn’t create financial statements at all, or they are not as savvy in the creation of them.”

Customers tend to be more comfortable with a balance sheet and profit loss statement, but that information is typically only relevant if you also receive a statement of cash flow additionally. “Profit loss and income statements are fluff,” said Chase. “It’s the movement of numbers to make the company look good, but there are only three places that cash comes from. For financial statements to be significant, you have to include a statement of cash flow.”

Yes, but: Though financial statements have several benefits in helping credit managers assess insight on how their customers’ business is financed and their financial health, several factors have impacted the value of financial statements alone.

Rising inflation and interest rates change how information is measured and presented in financial statements. Two factors mainly impacted by economic disruption include the customer’s ability to pay and discount rates. When the cost to fulfill sales increases, those additional costs may not be recovered. “The value of financial statements depends on the customer and the industry,” said Stinner. “If I am looking over a 10-year period, equity has increased. But I have seen in just the last two years that liquidity has taken a sharp decline, particularly the quick ratios.”

Some credit professionals do not use financial statements for information from their customers at all. They may look to use other tools such as credit reports as an alternative. “Any financial data is too old for us to use,” said Ronald Sereika, CCE, director of credit and client payment solutions at Mspark, Inc. (Helena, AL). “One suggestion if a new customer places an order and you cannot get enough information on them is to call the controller and see if you can have an honest conversation with them.”

For example, you can ask the controller about a $10,000 order and express concern with payment terms being Net 30 days and not getting paid within the time frame. If the information obtained from the customer shows they are paying 40-50 days beyond terms, you can request a $3,000 advance and see how the customer pays the balance. “This is where the most important of the five C’s of credit comes in: character,” Sereika said. “Credit reports are a tool that can be helpful in place of financial statements, but you will only get an idea of how they are currently paying instead of an overall picture.”

The bottom line: Be proactive when handling financial information of customers. While monitoring cash flow is crucial, a comprehensive understanding of a business’s financial health will always require an analysis of some form of a financial statement.