The experience acquired through the analysis of a myriad of credit operations, during the 13 years that I was linked to banking, has allowed me to identify some of the most common mistakes made when evaluating the financial statements of credit applicants.
A first mistake is to consider equity indebtedness ratios without taking into account coverage ratios. Thus, we have that a company can be highly indebted but generate enough Net Cash Flow to cover its current obligations and to raise.
A second mistake is to stick to liquidity ratios without considering the composition of asset accounts. Thus we find that a company with a high current ratio and positive working capital may paradoxically have liquidity problems, if its trade receivables are uncollectible or slow to recover and its inventories are obsolete or slowly rotating.
A third mistake is to ignore the activity ratios, not comparing the average days of collection, payment and inventories, with the policies of customer collections, supplier credit and expected inventory turnover.
A fourth error is to consider in the calculation of the ratios of average days of collection and payment, the total sales and purchases, when they should only be those of credit.
A fifth mistake is to consider that having a high working capital is good, when this implies maintaining an immobilized capital and an implicit financing cost.
A sixth mistake is to overlook important items on the Balance Sheet, such as other accounts receivable, payable, etc. They can have surprises. For example, deliveries to account that never come to fruition.
A seventh mistake is not asking for the correct breakdown of liability items. Generally, all liabilities are recorded “strangely” in the long term, affecting the calculation of liquidity and coverage ratios.
An eighth mistake is not taking into account that many times companies do not register all their obligations with suppliers, even worse if there are deferred checks involved.
A ninth error is to demand that the accumulated results be capitalized, as if it implies security of something, when in practice the company can reduce its share capital whenever it wants.
A tenth mistake is to forget that the important thing is to know the customer, which implies knowing who the formal and “informal” shareholders of the company are and what their character and reputation are.
Conclusions
In summary, in the current crisis and contraction of economic activity, analysts must take special care when evaluating company figures and never neglect qualitative analysis of the business.
