FINANCIAL STATEMENTS: HOW AND WHY THEY ARE IMPORTANT

A. The value of a financial statement


A financial statement is the financial picture of a company at a particular point in time. It is exactly the same as taking a picture of your children. Within a few weeks, they changed, didn’t they? Within a month or so, there are generally significant changes, right? Within a year or two, your kids don’t look anything like they did a year ago. Well, financial statements are exactly the same. A current financial statement is the only good financial statement. An audited financial statement is better than an unaudited one. What am I talking about: a financial statement is the picture of assets and liabilities. An operating statement is the sales and profit/loss. Both are dated. For example, a financial statement may be dated December 31, 2006. That statement might be valuable to determine credit transactions for several months. An operating statement is over a span of time such as January 1, 2006 through December 31, 2006. Sales and profits for a year are posted. Again, audited financial statements are better than unaudited ones. Simply put, the audit carries the reputation of the certified public accounting firm that prepared it. Why aren’t all financial statements audited? Simply put, they are expensive.


B. The “useful” components of a financial statement when extending credit or assessing collectability.


For extending credit, a couple of ratios come to the forefront. First, the current ratio. The current ratio is current assets divided by current liabilities. If current liabilities exceed current assets, watch out. The ideal is current assets substantially in excess of current liabilities. What this means to you: the company has sufficient assets to cover its debts. Also, examine:


Quick ratio, which is quick assets divided by current liabilities. Quick assets are assets that are quick to liquidate such as cash, accounts receivables, certificates of deposit. Current assets which would not be included as quick assets would be slow moving inventory. Hopefully, quick assets are sufficient to cover current liabilities. What this means to you: the company has sufficient cash and receivables to cover its current liabilities which are all of its short term debt (debt which is less than a year old). Even here, there are problems. What if the accounts receivable are no longer collectible? Oh No.


Net working capital ratio is net working capital divided by total assets. The net working capital of a company is its current assets minus its current liabilities.


Don’t get carried away with these ratios. There are whole courses on studying financial statements such as that found at www.investopedia.com. There is a printable 74 page advanced financial statement analysis form available free, absolutely free, at that cite. Topics include Whose in Charge?, The System, Cash Flow, Earnings, Revenue, Working Capital, etc.


C. Popular Terms


If you looked up the phrase Cash Flow, you would get a thousand different definitions if you searched a thousand different web sites. Commonly speaking, cash flow is something that debtors say they don’t have enough of. The first step in generating cash flow is to create sales. Sales put the product out the door. Accounts receivable bring the money back in the door.


If the company is not generating sales, they can’t generate cash flow. If the company doesn’t collect its receivables, there is no cash flow either. Example: I have run into a number of construction companies which has done work for the Katrina Hurricane Relief in New Orleans. None of them have been paid a dime, according to their managers, and they thought they were working for the federal government (FEMA) and thought they would be paid right away. If you don’t collect your receivables, you might as well not sell your product.


Working capital is another popular phrase. Working capital is the money used to pay short term obligations, such as paying vendor bills. In that sense, it is just like cash flow: debtors always claim they don’t have enough working capital. Businesses which have heavily invested in fixed assets, long term debt, and inventory build up have a hard time generating a good level of working capital. Once again, we look at the quick asset ratio; they don’t have enough cash, receivables, certificates of deposits and other assets quickly liquid in order to satisfy debt which becomes due in 30 days such as vendor obligations.


Tons of Tips on Credit and Collections: THE book, Credit and Collections Kit

Real Stuff - No Fluff...

All my postings in this blog have been on topics of credit and collections, mostly collections.

Until this posting.

I just wanted to say "thank you" for your positive feedback...compliments.

Now back to your regularly scheduled programming!

No more fluff.

Honest.

Steve Harms

Collection Law: Tips for an enforceable personal guaranty

Is there a personal guarantee in a situation where a corporate officer has signed it as agent of the corporation?


Consider a case where a document signed by the guarantor titled “GUARANTEE OF LEASE,”which identifies the signor as a “Guarantor” and it provides, in part: “IN CONSIDERATION of the making of the above lease by the Lessor….the undersigned….as a direct and primary obligation, guarantees, to the Lessor and any assignee….the prompt payment of rent.” It allows the creditor to proceed directly against the guarantor without first pursing the corporation.


The catch is that he signed it with his name followed by the word, “President”. This, argued the signor, created ambiguity and removes any personal liability (that is, he claims he was acting as “president” or an agent of his company which means he is NOT personally liable for payment of the document.)


This is actually a good argument under the Uniform Commercial Code. Our office has cautioned our clients for years not to allow a guarantor to sign in any capacity other than individually. In other words, don’t allow a personal guarantor to sign his name, then insert a comma and the word “president” or “vice president” or any such title which would tend to show he is acting as an agent rather than in his individual capacity.


The trial court, however, found in favor of the creditor by denying the agreement was at all ambiguous. The court found the word “president” appeared to be no more than a descriptive word of who the defendant was….and stated “Indeed, a corporate guarantee would have been meaningless, given that AFG was already bound as principal….Although a court may reform a contract to reflect the parties’ actual intent where the evidence clearly shows a meeting of the minds that was not properly expressed in the instrument...the trial court here properly enforced the contract as written, in accordance with its clear and unambiguous terms.”


So, we won that one for our client…but, to be honest, it could have gone the other way very easily! So, again, the lesson to be learned here is: don’t allow your personal guarantor to use a title after his name!










Tons more practical tips on CREDIT and COLLECTIONS!

Entering into Contracts: Make them complete and clear!

Business contracts are always the subject of much litigation. It seems that there is no such thing as a “bullet proof” contract or a contract which just can’t be interpreted more than one way.


So, when is this a problem? Well, to start with, any ambiguity in a contract is generally held to be the fault of the drafter (author) of that contract. Simply put, if there is a vague term in a contract, the courts will side against whoever wrote it!


That having been said, we can’t always adopt a philosophy of letting the “other guy” write up the business agreements we enter into for the simple reason he won’t include many of the terms or conditions we think are essential! So, we write contracts as best we can.


A recent Michigan case involved a contract between a manufacturer’s representative and the company he represented. The company made steel wheels for the automobile industry. Interestingly enough, the parties entered into a written contract which left out a very important term: how much commission the representative would earn on sales of the wheels!


After obtaining several lucrative contracts with Ford and Chrysler, the rep and the company couldn’t agree on a commission rate, and a law suit was started to establish one. Although the court did not leave the rep without a remedy, it did admonish both parties that this was really “an agreement to make an agreement” and therefore there was no contract!


The court did award damages in favor of the representative on other theories, but we are once again reminded to make sure our contracts are clear, easy to interpret, and contain the important terms!



One good thing the Uniform Commercial Code (UCC) does for us, is to fill in some essential terms such as delivery terms, and even a price term. Why wasn’t the UCC used by plaintiff manufacturer’s rep in the case cited above? Simple. The UCC only applies to the sale and leasing of goods, and a representative’s contract is really a service contract between a manufacturer and a representative.

Webinar on the Legal Process (collecting accounts through law suits)

Just a quick note: I'm presenting a webinar on May 4th for 90 minutes (copy available for download if you can't join us live), sponsored by the International Association of Commercial Collectors, at web site:
http://www.commercialcollector.com/scriptcontent/index.cfm

Why do attorneys request an affidavit to file suit?

Good question!  Attorneys ask for an affidavit to support the account when we file a collection suit in order to establish a case.  Simply put, the case requires the defendant (your debtor or former customer) to come forward with facts and a counter affidavit as part of his or her answer if they truly dispute the account and want to establish a valid defense to your collection law suit.prima facie prima facie

Essentially, the affidavit and the account ledger go together hand-in-hand to establish our case in court.  In fact , the combination of the affidavit and the account ledger is referred to as an , which legally means the defendant so far has not objected to the amount sued for.  While the burden of proof is always on the party bringing the suit (the plaintiff), the account stated case does present a strong case, and helps us test the debtor’s (the defendant) defenses.account stated