Credit management: tips for evaluating business credit risk.To help credit managers better manage risk following the recent wave of corporate reporting irregularities, Atradius Trade Credit Insurance has developed a list of "Ten Hiding Places for Business Credit Risk." The firm is the U.S. arm of Atradius Group, the second leading credit insurer in the world. The hiding places are: 1 Capitalization capitalization n. 1) the act of counting anticipated earnings and expenses as capital assets (property, equipment, fixtures) for accounting purposes. 2) the amount of anticipated net earnings which hypothetically can be used for conversion into capital assets. -- Evaluate how the firm is capitalized Capitalized Recorded in asset accounts and then depreciated or amortized, as is appropriate for expenditures for items with useful lives longer than one year. and if it has reliable access to future capital. Determine sources of capital and how the capital is structured. 2 Loss on Derivatives derivatives In finance, contracts whose value is derived from another asset, which can include stocks, bonds, currencies, interest rates, commodities, and related indexes. Purchasers of derivatives are essentially wagering on the future performance of that asset. -- Find out if complex hedging strategies are in place that may not be actual hedges. Determine if derivatives used are liquid and if there are "naked" positions. 3 Mark-to-Market Accounting -- Ensure derivative derivative: see calculus. derivative In mathematics, a fundamental concept of differential calculus representing the instantaneous rate of change of a function. positives in place are valued correctly and find out valuation rationale rationale (rash´  nal´),n the fundamental reasons used as the basis for a decision or action. . Determine if rationale has material impact on financials. 4 Managing Leverage with New Forms of Debt -- Determine if convertibles that look like equity actually act as debt triggers. 5 Goodwill and Intangible Valuations -- Assess what assets are being valued and at what price. Check to see if big write-offs are coming. 6 Off-Balance-Sheet Transactions -- Determine if there are operating leases Operating Lease A lease contract that allows the use of an asset, but does not convey rights similar to ownership of the asset. Notes: An operating lease is not capitalized it is accounted for as a rental expense. that should be capital leases or capital leases that should be operating leases. 7 Calculating Pension Liability -- Reconcile estimated needs with the projected returns and see if projections are realistic. Evaluate how options are treated. 8 Financial Engineering with Special-Purpose Entities Special-Purpose Entity A financing technique in which a company decreases its risk by creating separate partnerships, rather than subsidiaries, for certain holdings and solicits outside investors to take on the risk. (SPEs) and Joint Ventures (JVs) -- Find out if companies are being set up to assist in product financing to customers of the parent and determine the effect on the parent if the entity fails. 9 Engineering with Mergers and Acquisition Activity -- Establish if any mergers or acquisitions impacted the firm's overall debt/risk ratio. 10 Revenue Recognition and Measurement -- Determine if the company is booking future revenue in current periods for long-term contract deals and if unrealized revenue is being calculated correctly. Check to see if swap transactions overstate revenue and add no realized value. Assess how currency value affects earnings. |
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