Thinking about Credit by T.H. Donaldson

By T.H. Donaldson

This booklet is a sequel to the author's past wondering credits (also released via Macmillan). once more, he applies his undoubted adventure to a few themes within the sector of credits review and administration.

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We may say 'leverage looks high and cash flow coverage low, but because of the local practice of hidden reserves they probably are not as bad as they look'. If we are right about the direction of the transfers, and at least the general extent of the reserve, we are probably also right to accept the apparently weak condition. But we need to be sure we are right. A company may start 48 Examples with an apparently weak balance sheet which is stronger than it looks because of its hidden reserves. If it then dissolves the reserves to avoid reporting losses (and a weakening balance sheet) when the bank thinks it is making profits and building up hidden reserves further, the result can be disastrous.

A company may start 48 Examples with an apparently weak balance sheet which is stronger than it looks because of its hidden reserves. If it then dissolves the reserves to avoid reporting losses (and a weakening balance sheet) when the bank thinks it is making profits and building up hidden reserves further, the result can be disastrous. But in a climate where hidden reserves are accepted practice, we can hope to judge which company is doing which only on a case by case basis. Averages are no help at all.

Only then can we use the comparisons to illustrate key points. The Wrong Way The wrong way, then, is to use industry comparisons to cover up lack of real knowledge about the industry, and about what are the key factors. Too many industry comparisons consist of long lists of ratios, which enable us to say that our company is more highly leveraged, has a higher cash flow, is more liquid, has higher margins on sales (or worse in each case) than the average for its industry. They do not, however, tell us how much each ratio matters to this industry.

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