Credit Analysis
The special purpose financial statements are financial statements that are only limited to specific users. They are prepared using a special purpose structure to meet the special needs of particular users of a financial statement. Addition their use are limited and are not prepared for the general public. Special purpose statements are in most cases prepared for the internal users such as management and there are these made for the specific users such as banks and government. For instance, those financial statements that are prepared for tax purposes are prepared in accordance to the regulatory framework. Therefore, the special purpose financial statement are different in sense that they are prepared with compliance to a particular framework that is different from general purpose financial statements.
Question 1b
The special purpose financial statement is important to the lender because they are simplified and contain information that explains the financial statement. This information helps the lender to be able to analyze and interpret the financial situation of the firm. To be specific, this type of financial statements helps the lender to conduct the credit analysis that derives various types of debt that are incurred by the firm. Thus, the lender is able to determine the probability of repayment of debt on speculated time and in full. Therefore, the analysis of financial statements is done to considerably guide in a decision to not to or extend credit by the lender.
Question 2
The financial statements provided by the Boat Builder Ltd are not accurate enough to depict the true financial position of a firm. It is essential to remember that the financial statement represents the past performance of the business. Thus the financial statements provided by this firm cannot accurately portray the true financial position of the business. The financial statements are not appropriate because they are not sufficient, that is, no income statement and cash flow statement that offers substantial information to compute the ratios.
The ratios that can be computed to illustrate the financial position are not sufficient enough to give the correct analysis of the business. There is ignorance in accounting assumptions such that the expenditures in the statement of financial performance are not differentiated into consumed and incurred expenditure in that period. This violates the assumption of accounting period. The financial statements are also prone to errors such as mistake in applying GAAPs and deliberately misstatement of numbers. The misstatement of numbers may be as a result of misapplying accounting rules as false booking accounting.
Question 3
As a lender I would rank may concern as the following;
Insufficient financial statements
Lack of a well prepared income statement and cash flow statement can be ranked as the first concern because they provide a vital role in computing ratios that portrays a financial performance of the business. The lender is more concerned to know how the business is operating and the certainty the firm can experience in paying back the money lend. Cash flow statement derives the ratios that are significant in determining whether to lend money or not. For instance cash flow to capital expenditure ratio can be used to determine the financial flexibility of a business. That is, the higher the ratios the more vulnerable for a company to experience financial flexibilities.
Financial statements are prone to errors
The financial statement errors are also vital in the decision making of lending out money. If the accountants are not more careful and do not comply with the accounting principles, there are high chances of a firm to incur significant losses. Therefore, as a lender I would always avoid transacting with such business because I would end up experiencing band dept.
The ignoring of accounting assumptions
Failure to make distinction between the expenditure incurred and expenditure consumed in particular period can result into incorrect expenditure that can be carried forward into the nest financial year. Such concern can be considered to more applicable for lenders in their decision making. This is because time and certainty of information is disrupted.
Question 4
As a lender is would like to ask certain questions, which are related to my concern, to the owner of the business so I can be able to know the credit worthy of the business. Such questions are as follows
How can the proprietor or the accountant provide relevant information that can assist in determination of the firm to expand its equity basis?
As a lender, how can I determine the effectiveness and efficiency in management that can enhance profitability of the business?
How is the flexibility of the financial in the firm that determines the dependency of the firms’ external sources of funds? How much the firm does relies on the external funds?
How does the firm ensure that it does not violate the accounting principles and assumptions?
How does the provided information support the financial statement for easy understanding of the components?
Question 5
On the first question, the decision carried by the management to expand the equity basis can only be solved by computing the return on equity ratio. The computation of this ratio involves the combination of the balance sheet items and the earning items. The ratio is given by; net income / (common equity + preferred equity). Therefore, the income statement has to be modified to derive the net income. To calculate the net income, expenses are deducted from the gross profit, revenue is added and then the tax deductions are made. Therefore, the firm must provide additional information to assist in computing this net income.
The next question concerns the financial flexibility of the business that is crucial to the lender so as to determine the effectiveness in generating the substantial cash to pay the bills. If a firm cannot be able to generate substantial cash to pay the bills the firm is not therefore vulnerable for lending out funds. For the businesses that are capital intensive the significant ratio is the cash flow to capital expenditures, which is given as; Cash flow from operating / capital expenditure. To be able to compute the ratio the accountant has to carry out modification in the financial statement of the firm. The modification involves preparing cash flow statement that can be used to derive the cash flow from operating amount that is needed to compute the ratio. After the determining the ratio, the lender will be able to determine the risks of the business. This is because a firm that depends on external sources of funds operates on greater risks than a business that can retrench when new capital becomes prohibitively expensive or scarce.
The concern on to reduce errors in the financial statements should be solved by introducing an auditing team that can reduce errors in the statement and provide accurate documents. Modification such as modifying income statement and adding the cash flow statement should be considered. The accounting assumptions should also be followed to ensure that consumed expenditures and incurred expenditure are differentiated to be carried forward effectively in the next financial period.
In order to be able to understand the financial statements, the substantial information has to be added along the financial statements. Thus the modification to be made involves adding the supporting notes that explains the components of the financial statements. In addition the accounting policies must be sufficient enough to explain the basis under which the financial statements have been prepared. In conclusion, all these questions will assist to modify the financial statements and provide sufficient information that can accurately determine the real position of the business.
