© 2000 John Petroff
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© 2000 John Petroff |
This form of debt should be used by all firms if it is available. As shown in Table T-8.4, in the construction, manufacturing, wholesale and retail industries the average days-purchases-outstanding ratio is 26, 27, 26 and 25, suggesting that the most common terms are net 30 days and that all firms use them but do not abuse them. An analyst may come across an occasional firm that does not take advantage of the terms available, and should find out if the reason is that the firm is denied open account privileges which would be a serious weakness, or that the firm takes the prepayment cash discount which would be an indication of strength and financial wisdom. Indeed the cash discount has often an implied rate of return much higher than that available on marketable securities. In some industries and for some slow paying companies, trade credit can be formalized with trade notes. One must verify that this formality is common practice or the company is singled out as being unreliable.
Seasonal credit, revolving credit and other credit lines are used by all firms to finance working capital and as a initial safety, in case of difficulties. The notes to financial statements should show the unused portion of available credit and whether the corporation is charged for such stand by credit. An analyst can recognize the first signs of some form of financial hardship in an unexpected jump in the use of short term credit, and especially is a company's inability to extinguish it within a period of 12 months as it normally should be.
3)- Notes, commercial paper, acceptances, letters of credit
These are isolated on the balance sheet in some industries where their use is common, but in other industries they may be lumped together with trade credit, or short term bank credit. When comparing firms, stronger firms usually have easier time selling commercial paper and this item may be larger than that of weaker firms.
Other than various accrued expenses and minor liabilities, one may find in this item taxes payable and deferred income tax liability, as well as dividends payable. Taxes are further explained and reconciled in notes. This reconciliation can be used to analyze the tax policy of the company and check if the firm has recognized some unusual gains or losses that do not appear in the income statement. Another liability that is usually shown separately from other current liabilities (if it is substantial) is the current portion of long term debt. If a year to year correlation does not exist between this item and the outstanding balance of long term debt, the analyst should investigate if a debt has recently been issued or retired. The statement of cash flows is useful to conduct the investigation. A sizable increase in current portion of long term debt or in other current liability can be an indication that the firm is encountering difficulties.
See review questions Q-12F.1 through Q-12F.8.
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