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Financial statement spreading is a time-consuming, repetitive, and yet quite a fundamental process for banks on multiple fronts. In this article, we are going to expand on the meaning of the term, talk about what this process hopes to achieve, and how it helps in credit analysis.
What is Financial Statement Spreading?
Financial statement spreading, by definition, is the process of transferring information from a borrower’s financial statements and feeding it to the bank’s financial analysis spreadsheet. It can involve inserting the borrower’s financial statements and tax documents that go back years into a special credit spreading software, thus helping the analyst spot trends over the years and understand the borrower’s financial condition.
In other words, financial statement spreading is about analyzing data from existing financial statements to predict future financial statements.
The results we get after the said analysis consist of the following:
- Balanced ratio between the borrower and the bank
- Financial income statements
- A complete account report
- Rapprochement of net worth
- Updated cash flow statements
While the reports might give you more, banks generally set benchmarks with these points and use them as a standard against other borrowers. They tally the ratios to assess the risk of sanctioning the loan and how much the company can liquidate if it can’t pay on time. So, to put it into perspective, financial statement spreading helps reduce risk, although the methods of implementation vary with banks.
It is predominantly a manual or a semi-manual process at best which makes it resource-intensive and prone to error. This, by extension, means that this exercise, at present, is less efficient and can lead to incorrect analysis. Therefore, this hints at the impending need for automation to some degree with an intelligent OCR tool, balance sheet analysis needs a bit of human touch.
Methods of spreading financial statements
When it comes to banking analysis, it’s predominantly about financial spreading, and its methods vary with every institution. Although each method is unique in its own right, a few elements in the process of financial spreading remain common. For instance, spreadsheets are by far the most common means of inputting financial data. Organizing it may demand some expertise, but given the grid design, it’s the most efficient way to update all values.
Some banks also like to use balance sheets to input data while spreading financial statements since they mostly have the same characteristics as income statements. Plus, a balance sheet is designed to maintain a tally of assets and liabilities, which makes spreading any borrower’s financials appear seamless.
Objective behind financial statement spreading
Financial statement spreading aims to present highly granular financial information to banks in a bid to aid them in making strategic business decisions and support investment advisory, credit appraisals, and rating analysis. The process of financial statement spreading generally comprises multiple counterparties viz. listed and unlisted entities in different countries, and sometimes different languages.
What do financial statements contain?
Financial statements submitted by borrowers are essentially documents that contain data points describing the company’s financials. Companies release these documents monthly, quarterly, or yearly and include information such as their earnings, expenses, assets and liabilities, operating budget, and so on. Financial planners like accountants use financial statements to anticipate future projects, product launches, and expansion. On the other hand, bankers use these documents to assess risk before processing loans.
Conformity to GAAP
While financial statement spreading appears to be a simple activity of transposing the borrowers’ financials in the bank’s system, it is noteworthy that these spreads don’t always conform to GAAP. Here’s where banks might deviate:
- Long term liabilities have been spread as current liabilities
- Current assets have been spread as non-current assets
- Assets lack the potential to be liquidated
- Non-current assets may consist of restricted current assets.
Having said that, most of the information is spread just according to GAAP.
How does it enable credit analysis
Financial statements are the most direct and authentic way to determine how much the borrowing company makes every year in sales. While the sales may deflect every year, analysts can identify patterns with these figures. For instance, the company may show signs of increasing sales whenever they roll out a new product, which might drop after some time in the market. Regardless, it shows potential, and this is a highly leveraged parameter for credit analysis.
Financial statement spreading also reveals the borrowing company’s budgets. So, if the analyst needs to assess the company’s decision-making ability and future planning, the budget tells them. If the company doesn’t have any buffer for launching new products or extending its marketing campaign, it’s a red flag, which means the company may end up spending more than what its budget dictates.