Forensic credit

A commercial loan officer for a leading commercial lending bank boasted back when banks were aggressively lending money, that he had recently signed a multi-million dollar operating credit line for an excavating company. I was a little surprised because banks as a rule, even then, were reluctant to lend to contractors. They generally have no assets other than equipment and I suspected the excavator’s was probably leased. The bank officer told me the contractor had a very large accounts receivable. “It’s secured.” The loan officer said confidently, “He said he has Stop Notices on all of it.”

The banker had been convinced that Stop Notices secured the receivable. I explained to him that in California, a Stop Notice was the first step that a contractor takes when payment is not forthcoming. It does not guarantee anything. For one, the notice only stops whatever money remains un-disbursed. Worse, if it was a public works project, the public agency is allowed to disburse as needed to complete the project regardless of any Stop Notices. In short, I told the banker, it was very possible, the excavator’s accounts receivable was an illusion.

The bank had done its homework and had sent in a team of auditors to review the excavator’s financials. Because the auditors knew more about accounting practices than they did about the realities of construction they were given a convincing spiel about Stop Notices that convinced them an everyone else that the receivable was secured.

I once explained to a team of bank auditors how the ready mix industry secured their accounts receivable with lien rights. The auditors believed that a lien was synonymous with second trust deeds. Allowing them to believe that resulted in a very favorable audit even though, filing liens was often a prelude to filing a suit to recover money and the outcome rarely resulted in full payment.

More recently, a team of auditors from one of the nation’s leading accounting firms was conducting a Sarbanes Oxley compliance test. They were looking at all of the company’s financial procedures and when they came to the accounts receivable they asked how they were reviewed. I explained the process which involved generating aged trial balances, identifying the delinquent accounts as well as accounts over credit limit and reviewing the collection progress with the collectors. It was a lengthy and involved process; too long for the auditor, who, distilled the entire process into “signing the aged trial balance.” Thus, the entire function of making sure the accounts receivable was being worked was reduced to a mandatory signature on the last blank page of a computer generated aging no one but the credit manager ever saw. It was a conclusion drawn from a lack of understanding the credit function and a desire to keep it simple.

In a time when more than ever stock holders and now the tax paying public are demanding accountability from major corporations and the leading accounting firms are expected to police businesses and restore confidence, there should be a higher level of commercial credit knowledge and not just accounting smarts. Perhaps there should be more “forensic credit” just as there is a need for forensic accounting.

That’s where CreditPowers can help. We know credit functions. We know when accounts receivables are secured by more than smoke and mirrors. We can do an assessment of the receivables and assist auditors in determining the strengths and weakness. We can provide a level of confidence and credibility that is so lacking.

For more information e-mail patrickpowers@sbcglobal.net