Introduction to Credit Management

Every balance sheet is grouped by assets, liabilities and stockholder’s equity. The balance sheet information is a basis for analyzing the sources of earnings. If assets are overstated, earnings will also be overstated because they will not include those charges required to reduce the assets to their proper valuations. Consequently, when liabilities are understated, earnings will be overstated. The asset quality depends on factors like changes in industry and economic conditions, and changes in the operations of the firm.

Assets can be divided into different risk classes, for example, the future realization of accounts receivable has a higher degree of probability (lower risk) than the future realization of goodwill. A current asset is expected to be converted into cash during the operating cycle of a business. By analyzing the balance sheet one has to be aware of the existence of off-balance-sheet items. They are not disclosed in the balance sheet but have an effect on the financial situation of a company.