In the last issue of Creditworthy News Rich Hill discussed the
importance of the Statement of Cash Flows. It has long been recognized
by those who analyze financial statements that this is the most
revealing of the five components of a financial statement.
One of the classic
examples of the importance of this document was the events leading up
to the bankruptcy filing by the Southland (7-11) corporation in the
early 90’s. Southland was the first company to file a
prepackaged bankruptcy petition, meaning they had creditor approval of
their reorganization plan prior to filing bankruptcy. This type of
filing is the blueprint for the proposed Chapter Ten filing in the
revised bankruptcy law.
Southland was unique
in that the majority of its trading partners were wholly owned or
majority held subsidiaries. The company chose to take itself private
just when the economy was heading south in the late 80’s and
ultimately found itself heavy with bondholder debt while income from
operations were declining. In order to repay the bondholders timely it
began to sell off its’ subsidiary companies. Unfortunately the
economy did not recover sufficiently and after selling off all its
assets Southland was faced with either selling all its remaining
stores or seeking protection from its creditors.
Those creditors who
studied the statement of cash flows were prepared for the inevitable
because they recognized the cash was coming from investments and being
used to pay down bondholder debt rather than from operations.
The majority of credit
professionals report that they are unable to obtain financial
information because the customer refuses to provide it and if they
push for it they risk the customer switching to the competition.
Furthermore, they often state, incorrectly, that there is no law that
provides them access to this information.
For those who sell
product, Article Two of the Uniform Commercial Code provides for
obtaining financial or similar information. §2-609 provides for both
the buyer and the seller of goods the Right to Adequate Assurance of
Performance. §2-609(1) reads in part: “when reasonable grounds for
insecurity arise with respect to the performance of either party the
other may in writing demand adequate assurance of due performance and
until he receives such assurance may if commercially reasonable
suspend any performance for which he has not already received the
Extension of credit is
founded on the principles of the three C’s. Character, capacity and
capital. Capacity and capital generally are determined by financial
information contained in the balance sheet. Capacity is equal to
current assets minus current liabilities and capital is determined by
subtracting total liabilities from total assets.
“after receipt of a justified demand failure to provide within a
reasonable time not exceeding thirty days such assurance of due
performance as is adequate under the circumstances of the particular
case is a repudiation of the contract.”
are an integral part of credit analysis and should be required from
all customers who seek credit terms. First and foremost a financial
statement is “managements report card” and the businessman who
does not have a current financial statement is not privy to what he
owns and what he owes.
Today, more than ever,
it is important for us to recognize and communicate to both the
internal and external customer that credit is a privilege that is to
be earned by providing the necessary information that allows us, as
credit professionals, to do our job efficiently.
I wish you well.