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Financial Information For Lending Decisions

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1. Performance Data for Lending Decisions A Guide to Comparing Sources of Financial Information 2. Why Care? Why Now? <ul><li>New economic realities suggest…
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  • 1. Performance Data for Lending Decisions A Guide to Comparing Sources of Financial Information
  • 2. Why Care? Why Now? <ul><li>New economic realities suggest the need for better information </li></ul><ul><li>Rules governing CPA’s have recently changed </li></ul><ul><li>Plain English explanation of CPA’s work </li></ul><ul><li>Reminder of basics </li></ul>
  • 3. General Outline <ul><li>The Lending Decision </li></ul><ul><li>Sources of Data </li></ul><ul><ul><li>CPA prepared financial statements </li></ul></ul><ul><ul><ul><li>Definition – Balance Sheet, Income Statement, Cash Flow Statement & Notes </li></ul></ul></ul><ul><ul><ul><li>Audited </li></ul></ul></ul><ul><ul><ul><li>Reviewed </li></ul></ul></ul><ul><ul><ul><li>Compiled </li></ul></ul></ul><ul><ul><li>Management prepared financial statements </li></ul></ul><ul><ul><li>Income tax returns </li></ul></ul><ul><li>Costs </li></ul><ul><li>Independence – Who’s Reporting to Whom </li></ul><ul><li>Questions </li></ul>
  • 4. The Lending Decision Process <ul><li>Borrower Needs </li></ul><ul><ul><li>Cash for Expansion or Startup </li></ul></ul><ul><ul><li>Reasonable Cost </li></ul></ul><ul><li>Lender Needs </li></ul><ul><ul><li>Reasonable Return </li></ul></ul><ul><ul><li>Acceptable Risk </li></ul></ul><ul><ul><ul><li>Data to Assess Risk </li></ul></ul></ul><ul><ul><ul><li>Collateral </li></ul></ul></ul>
  • 5. Sources of Data <ul><li>Financial Statements </li></ul><ul><li>Business Valuations </li></ul><ul><li>Income Tax Returns </li></ul><ul><li>Property Appraisals </li></ul><ul><li>Credit Reports </li></ul><ul><li>In-House Data </li></ul><ul><li>Key Performance Indicators (ex. units sold, subscribers, etc.) </li></ul><ul><li>Forecasts </li></ul>
  • 6. Financial Statements <ul><li>Management Prepared Statements </li></ul><ul><ul><li>Bookkeeper Prepared </li></ul></ul><ul><ul><li>Quick Books </li></ul></ul><ul><ul><li>Other Software </li></ul></ul><ul><ul><li>Spreadsheets </li></ul></ul><ul><ul><li>The Shoe Box </li></ul></ul><ul><li>CPA Prepared Statements </li></ul><ul><ul><li>Audited </li></ul></ul><ul><ul><li>Reviewed </li></ul></ul><ul><ul><li>Compiled </li></ul></ul><ul><ul><li>Management Use Only </li></ul></ul>
  • 7. CPA Prepared Statements Levels of Assurance
  • 8. Management Use Only Financial Statements <ul><li>Management directs CPA how to prepare statements to suit his or her individual needs </li></ul><ul><li>Management agrees to not disclose to third parties......bankers </li></ul><ul><li>No requirement to follow GAAP (Generally Accepted Accounting Principles) </li></ul><ul><li>Generally no footnote disclosures </li></ul>
  • 9. <ul><li>If you are presented financial statements that have “Management Use Only” printed somewhere, it is in violation of the agreement not to provide to third parties. </li></ul>
  • 10. Compiled Financial Statements <ul><li>CPA “compiles” management prepared figures into proper financial statement format </li></ul><ul><li>Footnote disclosures </li></ul><ul><li>No CPA independence required </li></ul><ul><li>Minimal evidence is required </li></ul><ul><li>No requirement to verify client assertions </li></ul><ul><li>May be disclosed to third parties </li></ul><ul><li>No assurance or opinion is provided </li></ul>
  • 11. Reviewed Financial Statements <ul><li>Ratio analysis </li></ul><ul><ul><li>Comparison to prior years </li></ul></ul><ul><ul><li>Comparison to industry peers </li></ul></ul><ul><ul><li>Comparison to management expectations </li></ul></ul><ul><li>Interview of key management personnel </li></ul><ul><li>CPA independence is required </li></ul><ul><li>No internal control investigation </li></ul><ul><li>No search for fraud </li></ul><ul><li>No testing of evidence </li></ul><ul><li>CPA expresses limited assurance that financial statements are not misstated </li></ul>
  • 12. Audited Financial Statements <ul><li>Ratio Analysis </li></ul><ul><li>Interview key management personnel </li></ul><ul><li>Test a sample of evidence </li></ul><ul><li>Assess internal control </li></ul><ul><li>Assess risk </li></ul><ul><li>Assess compliance </li></ul><ul><ul><li>Taxing authorities </li></ul></ul><ul><ul><li>Loan covenants </li></ul></ul><ul><li>No fraud investigation </li></ul><ul><li>CPA independence is required </li></ul><ul><li>CPA expresses an opinion that financial statements are not misstated </li></ul>
  • 13. Management Prepared Financial Statements <ul><li>QuickBooks – by far the most common accounting software </li></ul><ul><li>Other Options </li></ul><ul><ul><li>Peachtree </li></ul></ul><ul><ul><li>Microsoft Accounting </li></ul></ul><ul><ul><li>Older packages </li></ul></ul><ul><li>Spreadsheets and various other methods </li></ul>
  • 14. Income Tax Returns <ul><li>Pros </li></ul><ul><li>No additional cost </li></ul><ul><li>Perjury declaration </li></ul><ul><li>Generally CPA prepared </li></ul><ul><li>Standardized </li></ul><ul><li>Cons </li></ul><ul><li>Significant differences between Internal Revenue Code and GAAP </li></ul><ul><li>Complexity </li></ul><ul><li>Filed four to ten months after end of year </li></ul><ul><li>No footnote disclosures </li></ul>
  • 15. GAAP versus IRC Asset Purchases <ul><li>GAAP </li></ul><ul><li>Written off over the asset’s useful life </li></ul><ul><li>IRC </li></ul><ul><li>Written off either: </li></ul><ul><li>At purchase (Section 179) </li></ul><ul><li>Over federally mandated life </li></ul><ul><li>Half upfront (bonus depreciation) </li></ul><ul><li>Combination of the above </li></ul>
  • 16. GAAP versus IRC Insurance <ul><li>GAAP </li></ul><ul><li>Life – Expensed </li></ul><ul><li>Health – Expensed </li></ul><ul><li>Property – Expensed </li></ul><ul><li>Liability - Expensed </li></ul><ul><li>IRC </li></ul><ul><li>Life – Deducted for employees (subject to ceiling), none for officers </li></ul><ul><li>Health – 100% deducted for employees, substantially limited for officers </li></ul><ul><li>Property – Deducted </li></ul><ul><li>Liability - Deducted </li></ul>
  • 17. GAAP versus IRC Travel & Entertainment <ul><li>GAAP </li></ul><ul><li>Travel – Expensed </li></ul><ul><li>Meals & Entertainment – Expensed if related to business </li></ul><ul><li>IRC </li></ul><ul><li>Travel – Expensed, but other methods exist other than actual cost (Mileage rates, per diem rates) </li></ul><ul><li>Meals & Entertainment – Generally 50% deductible, but complex rules govern treatment </li></ul>
  • 18. GAAP versus IRC Other Items <ul><li>GAAP </li></ul><ul><li>A/R & A/P – Included in results (Accrual basis) </li></ul><ul><li>Bad Debts – Losses recognized </li></ul><ul><li>Transaction with Owners – Included in statements </li></ul><ul><li>IRC </li></ul><ul><li>A/R & A/P – Cash basis might be allowed </li></ul><ul><li>Bad Debts – Ignored if using cash basis </li></ul><ul><li>Transaction with Owners – Included on owners’ returns </li></ul>
  • 19. GAAP versus IRC Bias & Motivations <ul><li>GAAP </li></ul><ul><li>Accurately quantify economic effect of operations </li></ul><ul><li>IRC </li></ul><ul><li>Minimize tax due by understating economic effect of operations </li></ul>
  • 20. Asset Depreciation Example Assume the Following: <ul><li>Crane </li></ul><ul><li>Costs $80,000 </li></ul><ul><li>Expected to last for ten years </li></ul><ul><li>Owners elect to expense all in year of purchase </li></ul>
  • 21. Asset Depreciation Example GAAP Expense $8,000 (1/10) Book Value $72,000 Best Estimate IRC Expense $80,000 Book Value $0 Understates Net Income EBITDA Expense $0 Book Value $80,000 Overstates Net Income Optimistic Conservative Pessimistic
  • 22. Independence <ul><li>Required for reviews and audits </li></ul><ul><li>“ Freedom from those factors that compromise, or can reasonably be expected to compromise, an auditor’s ability to make unbiased audit decisions.” – Independence Standards Board of the AICPA </li></ul><ul><li>More concept than specified set of rules </li></ul><ul><li>Ensure that CPA does not have a material financial or other interest in the subject company of an audit or review </li></ul>
  • 23. Common Causes of a Lack of Independence <ul><li>Direct financial interest </li></ul><ul><li>Participation in management </li></ul><ul><li>Family or close personal relationships </li></ul><ul><li>Unpaid fees </li></ul><ul><li>Employment </li></ul><ul><li>Expressing an opinion on one’s own work </li></ul>
  • 24. Independence <ul><li>Objectivity </li></ul><ul><li>Users of the audit or review report can know that the CPA is expressing an unbiased opinion as to whether the statements are free from material misstatement. </li></ul>
  • 25. Identifying Levels of Assurance Independent Auditors’ Report February 1, 2009 Acme, Inc. 1600 Pennsylvania Avenue Canton, GA 30114 We have audited the accompanying balance sheet of Acme Incorporated as of December 31, 2008 and the related statements of income, retained earnings and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain the reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Acme, Inc. as of December 31, 2008, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Murphy & McInvale, CPA’s February 1, 2009 Acme, Inc. 1600 Pennsylvania Avenue Canton, GA 30114 We have reviewed the accompanying balance sheet of Acme, Inc. as of December 31, 2008, and the related statements of income and retained earnings and cash flows for the year then ended, in accordance with Statements on Standards for Accounting and Review Services issued by the American Institute of Certified Public Accountants. All information included in these financial statements is the representation of the management of Acme, Inc. A review consists principally of inquiries of Company personnel and analytical procedures applied to financial data. It is substantially less in scope than an audit in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the accompanying financial statements in order for them to be in conformity with generally accepted accounting principles. Murphy & McInvale, CPA’s
  • 26. Identifying Levels of Assurance February 1, 2009 Acme, Inc. 1600 Pennsylvania Avenue Canton, GA 30114 We have compiled the accompanying statement of financial position of Acme, Inc, as of December 31, 2008 and the related statements of income, retained earnings and cash flows for the year then ended, in accordance with Statements on Standards for Accounting and Review Services issued by the American Institute of Certified Public Accountants. A compilation is limited to presenting in the form of financial statements information that is the representation of management. We have not audited or reviewed the accompanying financial statements and, accordingly, do not express an opinion or any other form of assurance on them. Management has elected to omit substantially all of the disclosures required by generally accepted accounting principles. If the omitted disclosures were included in the financial statements, they might influence the user's conclusions about the Company's financial position, results of operations, and its cash flows. Accordingly, these financial statements are not designed for those who are not informed about such matters. Murphy & McInvale, CPA’s
  • 27. It helps to be able to spot a set of QuickBooks financial statements....
  • 28. So, How Much Does it Cost? <ul><li>Compiled Financial Statements </li></ul><ul><ul><li>Typically $500 to $1,000 </li></ul></ul><ul><ul><li>Completed in one to two weeks </li></ul></ul><ul><li>Reviewed Financial Statements </li></ul><ul><ul><li>Typically $1,500 to $3,000 </li></ul></ul><ul><ul><li>Completed in one to three weeks </li></ul></ul><ul><li>Audited Financial Statements </li></ul><ul><ul><li>Typically $2,500 to $10,000 </li></ul></ul><ul><ul><li>Completed in two to four weeks </li></ul></ul>
  • 29. Questions & Discussion We can be reached at 2205 Riverstone Boulevard Suite 105 Canton, GA 30114 770.479.1667
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