There are several factors that portend danger in the performance of a firm. If a potential corporate lessee comes up with a proposal for a lease transaction, it is important to properly analyse the books and ensure the following signs are not available before venturing into such business. These can make the difference between success and failure of a lease transaction. Some of these factors include:
- Overtrading – which is a situation whereby a firm takes on more business than it can conveniently support with the resources at its disposal. This has serious consequences for working capital and can lead to losses. For example, if the firm decides to double its turnover and at the same time allows the same credit terms and payment period to its customers, the average amount owing to debtors will also double. Factory output that increases as a result of the decision would have the effect of increasing work-in-progress and raw material inventories. Thus, current assets will rise very sharply at almost the same rate as the increase in turnover and unless more cash is introduced, the level of working capital will remain unchanged except profits increase. When a firm overtrades, borrowing and operating costs also increase. To avert a cash crisis, an overtrading firm resorts to collecting its debts earlier than usual and loses customers in the process. It also postpones the payment of its own debts, thus losing the opportunity of obtaining further credit in future. The firm may also apply for a bank-overdraft to excess of its limit. In the final analysis, uncompleted inventory builds up, production falls behind schedule and labour is laid off to reduce costs.
- When there is a very rapid turnover among the firm’s top management especially among the directors from one year to another, it often means that the firm is not happy with the performance of its management and is also probably experiencing problems.
- If there is a noticeable late release of financial statements beyond the usual time that the firm normally publishes its annual reports, it often means that its auditors are not happy with certain things in the report and reluctantly appended their signature. Furthermore, if there is a change in the firm’s external auditors, closer observation may show that the auditors are having difficulty in giving a qualified report.
- A financial report that has too many footnotes should also be studied very closely: it may be concealing very important information about its performance. This tends to be common with firms that are having problems. They also tend to deceive the public by spending much money on public relations.
Essentially, ratio analysis assists the lessor (owner of an asset) in appraising the performance and potential of lessees (user of an asset) and arriving at proper decisions about their future. They, however, must be accompanied by qualitative and financial judgment.
To further play safe in an uncertain environment, it is better to uncover the secrets from the experts, and learn from the best. Contact 08023176691, 08023179048, info@elannigeria.org for further engagements