Credit & Financial Statement Review

Question 1

Examples of Sole proprietorship
Partnerships

Answer 1

General partnership
Limited partnership

Question 2

List the 4 Corporations

Answer 2

‘C’ Corporation
‘S’ Corporation
Not-for-profit
LLC

Question 3

Sole Proprietorship Definition

Answer 3

Individual(s) operating with a trade name- sometimes called a “DBA”

Does not require filing with State or Federal government in order to exist

• Does not insulate sole proprietor from liability – he/she can be sued for company debts
• No legal requirements to start the business outside normal business licenses and specific licenses that apply to the industry
• Owner can sign the contract
  Only one tax return; equity owners are personally taxed

Question 4

Partnerships Definitions

Answer 4

• Two or more individuals doing business usually documented via a partnership agreement
• Separate financial statement and tax return are prepared
• Income is generally reported before owners’ draws and taxes
• Income and associated tax liability is distributed to the partners through draws
• Tax liability for income or loss of the partnership is divided amongst the owners
• Lessor can go after the principals if the company defaults

Question 5

General Partnership

Answer 5

Two or more individuals, or entities

Each personally liable for all activities of the business and the ultimate liabilities

May be formed without filing with government (some states permit registration)

Question 6

Limited Partnership

Answer 6

• Two or more individuals, or entities, that come together to do business
• Can only be formed by filing Articles of Limited Partnership (usually with Secretary of State)
• Equity owners are personally taxed for profits
• At least one party needs to be the general partner, and others may be limited partners
  ~~General partners are liable for all activities and liabilities of the business
  ~~~Limited partners limit their liability to their investment (and any liabilities they personally guarantee)

Question 7

Corporations

Answer 7

• Legal entity in the view of the other businesses, state authorities, and taxing authorities

*Investors are shareholders, either common, preferred, or both, and liability is limited to investment plus any debts they individually guarantee

• Investors draw money through either salaries or dividends
  ~~Both taxable to the recipient
• Files a separate tax return, and pays taxes on profits of the business
• Dividends are distributed with after tax dollars

Question 8

C Corp

Answer 8

Basic form of corporation
At least one owner
Equity owners are not personally taxed for profits

Question 9

‘S’ Corporation

Answer 9

At least one owner
Equity owners are personally taxed for profits
Lessor cannot pursue principals if company defaults

Question 10

Not-for-profit

Answer 10

Entities for purposes OTHER than making profits for its owners or shareholders

Question 11

Differences Between ‘C’ and ‘S’ Corporations

Answer 11

In a ‘C’ corporation, the company will pay tax and the owners will pay tax

In an ‘S’ corporation, the owners take profit out of the company so that at the end of the year, only owners pay taxes, not company

Usually closely-held corporations

Question 12

Limited Liability Corporation

Answer 12

Hybrid of a partnership and a corporation

Operates as a partnership, but the partner’s liability is limited

Has members instead of stockholders and gains or losses are passed through to these individuals

Can only be formed by filing Articles of Organization (usually with Secretary of State)

Equity owners are personally taxed for profits

Minimum of one equity owner (some states require two)

Question 13

Three C’s of Credit

Answer 13

Character: the desire to repay the debt

Cash flow: the ability to make the payment

Capital: the ability to withstand unexpected negatives

***These are the three c’s according the handbook; however, there are others that people consider:
Capacity (basically the same as cash flow); Collateral; and Conditions

Question 14

Credit Scoring - Purpose

Answer 14

Consistent decisions

• Efficient process
  ~~Speeds up the credit department’s turnaround time by eliminating poor credit/approving good credits before credit staff sees them
  ~~Allows credit department staff to focus on applications not being automatically rejected or approved by the system

Availability of historical credit data as it relates to repayment outcomes

Test nugget – pay attention to all bullet points, and especially the “efficient process” bullet and sub-bullet points

Question 15

Credit Scoring – Data Used

Answer 15

Personal credit reports
~~Delinquency and bankruptcy models

Business credit reports
~~PayNet, Experian Business, D&B

Custom Credit Scoring Models
~Application information, personal credit data, and business credit data
~~SaiphTM by Orion First
~~SBSSTM by Fair Isaac

Question 16

Credit Enhancements

Answer 16

Security deposit
More advance payments
Shorten lease term
Additional guarantors
Vendor guaranty/recourse
Additional collateral
Fees/charges which reduce lessor’s investment
Vendor discount
Co-lessees

Question 17

Financial Statements – Compiled

Answer 17

Lowest level of assurance services

Conducted in accordance with Statements on Standards for Accounting and Review Services issued by the AICPA (American Institute of CPAs)

Limited to presenting in the form of financial statements information that is the representation of management

Question 18

Financial Statements – Reviewed

Answer 18

Next level of assurance services

Conducted in accordance with Statements on Standards for Accounting and Review Services issued by the AICPA

Consists principally of inquiries of company personnel and analytical procedures applied to financial data

Procedures-driven engagement with limited assurance provided regarding the financial statements

Question 19

Financial Statements – Audited

Answer 19

Satisfies external reporting requirements for lending institutions and regulatory agencies

Highest level of financial statement assurance service with an opinion of the fairness of the presentation

May only be prepared and issued by an independent and properly licensed CPA firm or CPA.

Question 20

Financial Statements – Audited

Answer 20

Unqualified Opinion
~Full audit has been performed
~Statements are according to GAAP
~Fairly represent the company’s financial status

Unqualified is the best possible outcome and most frequently reported

Question 21

Adverse Opinion in Audit

Answer 21

Full audit has been performed
Statements do not comply with GAAP
Statements do NOT fairly represent the company’s financial status

Before publishing an adverse opinion, auditors advise the firm’s accountants and officers of such problems. And, auditors then work with them to correct problems, insofar as they can. They do this hoping to describe the outcome as “unqualified” or “qualified” opinion, instead of “adverse,” if possible.
When auditors do report an adverse opinion, they give specific reasons for the opinion. As a result, auditors may point out specific accounting errors or departures from GAAP.

An adverse opinion has serious consequences for the reporting entity. At a minimum, the opinion ensures that reports will be rejected by investors, regulators, lenders, and governments. In addition, if the audit reveals illegalities, corporate officers may be held personally accountable.

Question 22

Disclaimer of Opinion
(In Audited Financials)

Answer 22

Not technically an ‘opinion;’ simply states that auditors chose not to issue an opinion

May be used when:
~~Auditor believes they cannot audit impartially (they recuse themselves)
~~Auditor’s scope is limited (can’t access certain data)
~~Auditors have other doubts

Auditors have other doubts about the reports. For example:
Reports may seem to violate accounting principles such as the matching concept or the conservatism principle.
Auditors may question the classification of certain revenues and expenses.
Some capitalized items probably should not have been capitalized.
They may question the way the entity applies rules such as the Lower of Cost or Market rule, or LIFO and FIFO rules for inventory.
Auditors issue opinions only when they are confident the opinion is supportable. Otherwise, they issue a disclaimer of opinion.

Question 23

Key Components of the Financial Statement

Answer 23

Accountant’s Letter
Balance Sheet
Income Statement and Net Income
Statement of Cash Flows
Accountant’s Notes

Question 24

Accountant’s Letter

Answer 24

Opening page and addressed to Board of Directors for corporation, general partner for partnership or the owner of a sole proprietorship

Confirms that the statements are prepared in accordance with GAAP

Question 25

Balance Sheet

Answer 25

Presentation of assets (what is owned), liabilities (what is owed), and the net worth (the difference between the two)

Captures the picture at the close of business one day in time

Question 26

Income Statement and Net Income

Answer 26

Presentation of the revenues and expenses for a specific period of time (in contrast to the Balance Sheet)

Most common are for one quarter, six months, or a year

Question 27

Statement of Cash Flows

Answer 27

In accordance with FASB 95, a statement of cash flows is required in the annual report

Shows a company’s cash receipts and payments during a specific accounting period

Reflects a reconciliation of cash; does NOT provide a credit view of cash flow

Non-cash items that may appear: depreciation, amortization, bad debt provision, impairment of goodwill

Question 28

Accountant’s Notes

Answer 28

Many analysts read the accountant’s notes first

Listing of significant points regarding specific balance sheet or income statement accounts that need to be understood when analyzing the other parts of the financial statement

A company’s operating lease commitments for the next fiscal year will appear in the Accountant’s Notes (Notes to the Financial Statements)

Question 29

Financial Ratios

Answer 29

Compare the results of the company being analyzed against results from calculating the same ratios in prior years to determine any trends in financial performance.

Compare the results of the company being analyzed against the same ratios computed for its industry peers to determine if the company’s financial performance is better or worse than its industry peers.

Question 30

Gross Profit on Sales

Answer 30

Gross Profit/Total Sales Revenue

Represents the percent of total sales revenue that the company retains after incurring the direct costs associated the goods and services sold

Higher percentage means the company retains more on each dollar of sales

Question 31

Current Ratio

Answer 31

Current Assets/Current Liabilities

Measure of a company’s ability to pay its short-term obligations

Higher ratio can mean slow receivable collection or excess inventory, but generally favorable

Generally want a ratio of more than 1.25:1

Question 32

Quick Ratio

Answer 32

Current Assets-Inventory/Current Liabilities

~~Consist of most current assets less inventories and prepaids
~~Over 1:1 is good
~~Indicates company’s ability to pay its current liabilities
Also known as the ‘Acid Test’

Aka- Liquid

Question 33

Debt to Equity

(Total Liabilities to Net Worth)

Answer 33

Debt/Equity

Higher number means more debt in relation to invested capital and retained earnings

Higher debt reduces the possibility of a full payout to creditors in the event of a business liquidation

Aka Leverage Ratio (a company is highly leveraged due to how much debt they have)

Question 34

Return on Equity

Answer 34

𝑁𝑒𝑡 𝐼𝑛Net worth of the company

Should be steady or growing when compared with industry data

ROE increases combined with increasing leverage may not be a positive indicator