This lesson covers the practical techniques used to standardise and interpret financial statements for credit assessment purposes. Financial statement spreading is a core skill for credit analysts .
6.1 The Purpose of Financial Statement Spreading
Financial statement spreading is the process of inputting a borrower’s financial statements into a standardised format for analysis . This allows lenders to perform consistent comparisons across periods and against industry benchmarks . Spreading is often performed using specialised software or spreadsheets, and it enables trend analysis and common-size analysis.
6.2 Common-Size Financial Statements
Common-size analysis expresses financial statement items as percentages of a base figure . For the income statement, each item is expressed as a percentage of revenue, enabling comparison of cost structures across companies of different sizes. For the balance sheet, each item is expressed as a percentage of total assets, allowing analysts to compare the asset and liability composition of different firms.
Key techniques include :
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Horizontal Analysis:Â Comparing financial data across multiple periods to identify trends.
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Vertical Analysis:Â Expressing each line item as a percentage of a base figure for a single period.
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Trend Analysis:Â Examining changes in financial data over time to identify patterns.
6.3 Adjustments to Reported Financial Statements
Analysts must often adjust reported financial statements to reflect the economic reality of a company’s financial position. Common adjustments include :
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LIFO to FIFO Conversion: Adjusting inventory values when a company uses Last-In-First-Out accounting .
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Depreciation Adjustments:Â Reconciling accounting depreciation with economic depreciation.
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Operating Lease Capitalisation:Â Converting operating leases to finance leases to reflect the true debt burden.
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Earnings Management Adjustments: Identifying and adjusting for accounting choices that distort reported earnings .
6.4 Accounting Quality Assessment
Assessing the quality of accounting information is a critical step in financial statement analysis . Credit professionals must evaluate whether reported earnings reflect the underlying economic performance of the company. Potential red flags include aggressive revenue recognition, inadequate provisioning, and unusual or non-recurring items . Understanding financial reporting choices and their impact on reported earnings is a fundamental skill for credit analysts .