Magazine article Business Credit

Nontraditional Analysis Tools Can Help Eliminate a Metrics 'False Positive'

Magazine article Business Credit

Nontraditional Analysis Tools Can Help Eliminate a Metrics 'False Positive'

Article excerpt

When it comes to deciding whether to extend credit, or how much, to a customer, credit experts rely on a number of tools from their professional arsenal to assess customers or prospects. Sometimes, however, the results don't tell the whole story and require another approach.

Charles Edwards, CCE, a regional credit manager, and Adam Easton, CCE, director of credit management-East, both for Ferguson Enterprises, Inc., recently said their company was grappling with how much leniency to grant one of its larger customers. "A lot of the traditional metrics were giving us a false positive," noted Edwards. The results led the credit department to dig deeper.

The credit professionals, who recently completed the NACM Graduate School of Credit and Financial Management (GSCFM), turned to a spreadsheet developed by GSCFM instructor Chuck Mulford. Many of his students such as Edwards and Easton have found that it's useful for all kinds of financial analyses. It provides a unique perspective on the statement of cash flows in a format that combines the indirect and direct methods into one.

How It Works

Mulford developed the Excel spreadsheet for financial analysis more than 20 years ago. "It's fairly involved and has been improved over the years," he said. "I don't teach to the spreadsheet at all. It's just a tool."

Unlike the indirect analysis method, this format reconciles every line item to its cash flow counterpart. "You're getting a full picture of the income and cash flow statements all in one," he noted. Then, it provides a cash flow drivers report that identifies each account change in cash-flow terms. "It will tell them how much of that change is due to growth in the business and how much is due to a change in fundamentals," Mulford explained. "It helps them analyze where cash flows are coming from and going."

It structures the information so that it's really focused on cash flow, Edwards said. "The spreadsheet incorporates a significant amount of data."

The data fields are predetermined. "It's pretty solid and is designed to be a template that's consistent with how he teaches," Edwards pointed out. "Fie gave us the spreadsheet already formatted so we can take the financial statements information and plug it in. It restructures that information and calculates using the nonconventional ratios Mulford teaches in class." Typically, the information comes from the customer's income statement, balance sheet and cash flow statement, Edwards explained.

Customers provide the financials, Easton noted. "You have to interpret the financials to input them into the spreadsheet."

When to Use It

Ferguson's credit department doesn't use it for every customer. Only for those that exhibit cash flow issues through changes in payment patterns in overall aging, Easton said.

He also added that it's "used to make immediate decisions on credit limits, adverse action, the overall future with the account, etc. We also track or monitor changes in the customer's cash flow position over time, especially those accounts where we have high A/R exposure or are just generally concerned."

With regard to Fergusons customer, "[The spreadsheet] got to the root of the issues," Edwards acknowledged. "It became apparent that over time the company was becoming more and more inefficient in how it was generating and spending cash." The analysis made a strong case for how they chose to proceed with the customer. "It's been a real success story," he said. "It justified a more conservative approach. We were able to enact some strategies to reduce their outstanding balance."

Diana Mota, associate editor, can be reached at dianam@nacm.org.

SAMPLE SPREADSHEET

Cash Flow Analysis Statements
Sample Company
31-Dec
Millions

                                         2013       2014       2013

Revenue from core operations           $ 10,500   $ 11,000   $ 10,250
Change in operating receivables           (251)        125          7
Change in deferred revenue                   --         --         --
Cash from revenue                        10,249     11,125     10,257
Cost of revenue                         (3,911)    (4,426)    (3,699)
  (excl. … 
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