Introduction to Credit Management

The income statement shows the revenues, expenses and income of a company for a certain period of time.  Important positions from the income statement are used to compute the profitability ratios and most importantly EBITDA (earnings before interest, taxes, depreciation and amortization) as a measure of cash flows from operations. It is important to assess whether net income has been determined based on conservative accounting policies or on liberal accounting policies which might not reflect economic reality and hence result in lower quality of earnings. High nonrecurring income as well as nonrecurring costs will bias the trend in earnings. An overstatement of revenues will distort profits. Revenue recognition practices vary across industries.

The financial analysis uses the information from the income statement, the balance sheet and the cash flow statement to compute various financial ratios. The purpose of the financial statement analysis is to evaluate the firm’s financial decision-making process and operating performance.

Nevertheless, we have to recognize that the information value of individual data items from the financial statements is quite limited. Financial ratios have to be examined in the context of the firm’s history, the industry, major competitors and the state of the economic cycle.

Furthermore, it has to be pointed out that the assessment of the financial situation of a company should not be static, but a dynamic analysis has to support the investment process. Financial numbers of a company have to be forecasted by the implementation of scenario analysis (e.g. worst case – base case – best case). By this means it can be shown whether a company will succeed in future and sales-, investment- and financing-plans will help to assess the dynamic liquidity position of a company.