2027 CLFP Recertification

With the leasing and finance industry focused on providing financing for the acquisition of equipment, understanding the basics of financial statements and financial ratios used in the credit decisioning process is a basic tenant for success and internal conversations.

Two critical financial reports are the balance sheet and the income statement. The balance sheet includes all assets owned by the company, all liabilities owed by the company, and the owner’s equity (aka net worth), all reported as of a specific date in time. The income statement reports revenues generated and expenses incurred over a specified period of time.

The basic balance sheet calculation is: Assets = Liabilities + Equity. Stated another way, Assets – Liabilities = Equity. Assets consist of current assets (cash, marketable securities, and other assets which can be converted into cash within the next 12 months such as accounts receivable and inventory) and long-term assets (items such as fixed assets which are amortized or depreciated over time such as buildings, land, machinery). Liabilities consist of current liabilities (debts and obligations payable within the next 12 months such as accounts payable, current portion long-term debt, interest payable) and long-term liabilities (debt and note payments due over a period exceeding the next 12 months). Equity is the claim of the owner(s) on the assets of the business and is generally comprised of the amount invested by the owner(s) (capital stock) plus retained earnings (total accumulated net income minus total accumulated dividends declared/paid).

The basic income statement calculation is: Revenue – expenses = net income/loss. If revenues exceed expenses, then a net profit is generated; if expenses exceed revenues, then a net loss is incurred — obviously, the former is preferred to the latter. Revenue is generated by selling or providing a product in return for payment. Typically, costs are involved to obtain goods sold, which may include the cost of inventory, cost to manufacture the goods, and/or costs to warehouse the goods until sold. Collectively, these costs are called Cost of Goods Sold (COGS) or Cost of Sales. The difference between Revenue and COGS is the gross profit, and the gross profit/revenue is the gross margin. In addition to COGS, companies incur operating expenses such as salaries, rent, utilities, machinery depreciation, and taxes. The final net income figure can be divided by revenue to determine the net profit margin, and net income can be divided by total assets to derive the return on assets (or ROA).

Credit underwriters analyze financial statements to determine applicants’ ability to service their obligations and to analyze trends. Some important ratios that are reviewed include cash flow coverage ratios (e.g. earnings before interest, taxes, depreciation, and amortization {aka EBITDA} divided by current portion long-term debt {aka CPLTD}); profitability ratios (e.g. gross margin, net profit margin, ROA, and ROE {return on equity}); liquidity ratios (e.g. current ratio which is current assets divided by current liabilities); and leverage ratios (e.g. debt-to-worth which is total liabilities divided by equity). These ratios can be compared to industry averages to help determine the financial strength of the applicant.