General Guidelines for Spreading Financial Statements

Purpose: This article provides a general guidance on spreading the financial statements of
foreign US borrowers or guarantors using any spreading software or excel spreadsheet. While
most of the banks are using Moody’s Risk Analyst software nowadays. Moody’s Financial
Analyst general purpose model is called Middle Market Analysis System (“MMAS”). This article
can also be used for other spreading software. The analyst should read the item in the financial
statement when performing credit analysis.

General Items:
A. Combined or consolidated statements - Note on the spreads if the statements are
consolidated or un consolidated, currency and if the figures are actual or are in thousands or
millions.

B. Auditor’s reports -Enter the auditor’s name and type of opinion: unqualified, qualified,
reviewed, Compilations, Tax returns and Company Prepared.

G. Financial statements and reports - Bank reviews the balance sheet, income statement,
statement of cash flows and the “Financial Ratios” report. We prefer reports where the local
currency and U.S. dollar equivalent values are listed side-by-side. However, if the software does
not generate side-by-side statements, we will review separate foreign currency and U.S. dollar
statements. Side-by-side statements can be printed in Moody’s MMAS model by selecting the
“Detailed Balance Sheet (or Income Statement) - Exchange Rate” report.

Balance sheet:
Assets are listed in order of liquidity in two sections, current and noncurrent. Liabilities are
shown in the order in which they are to be paid, again broken down into current and
noncurrent sections. Trade payables, short-term bank debt and accruals should be shown in
that order in the current section. Stockholders’ equity has permanent (or legal) capital shown
first followed by appropriated retained earnings and unappropriated retained earnings.

Assets

Current Assets:
Assets are defined as current if they will be converted to cash (receivables) or sold or consumed
(inventory) within one year of the balance sheet date. There’s a concept, not seen much in
practice if ever, called the normal operating cycle of a business, from purchase or manufacture
to collection for a sale, which for instance might be fifteen months or longer. Assets sold or
consumed during the fifteen-month period would be considered current assets.
• Cash and marketable securities - The two accounts can be combined or shown separately.
Don’t spread an overdraft account as a negative cash account. Instead, cash should be zero and
an overdraft liability account should be created. To be classified as a current asset, marketable
securities by definition must be easily sellable. availability restrictions for both cash and
marketable securities. If there are, conservatism would dictate classifying them as noncurrent.
Equity securities and debt instruments should be classified as current assets only if the
company’s intention is to sell them within one year. You should consider if such securities might
be long-term investments in related companies.

• Receivables (trade) - The nature of the receivables should be disclosed, trade or due from
related parties or stockholders. If they are not trade or, in the case of related party
receivables, trade related, and the statements are audited, the theory is that they will
be collected within one year. The same comment applies to “other” receivables.
• Related party receivables - They should show as a separate line item. Depending on
whether they are trade related or are loans, they should be placed in a line item in the
spread which results in their classification as an operating activity. If they are not trade
related, consider classifying them as noncurrent since they might in effect be long-term
investments.
• Other receivables - The comments in the previous section also apply to other receivables.
• Notes receivable - If the notes are trade related, they should be placed in a line item that
results in their being considered an operating activity in the cash flow statement as
opposed to an investing activity.
• Inventory - A breakdown is sometimes in order: raw materials used in a manufacturing
process, work in process and finished goods available for sale. Large changes in any
category should be questioned. The balances for raw materials and work in process
should be fairly low.
• Advances to suppliers - These advances result from up-front deposits made to suppliers.
If the balance is high, relates to inventory suppliers, and trade credit is low, this may not
be a good sign. Trade credit may not be available in adequate amounts. If it’s an
advance to a fixed asset supplier, it should be classified as a noncurrent asset since it
will be converted to a fixed asset account, not inventory. This account can be an
operating (inventory) or investing (fixed asset) activity.
• Work in process (“WIP”) - This is an inventory account which is seen in construction
company balance sheets. As the contractor accumulates costs in the form of direct
material, direct labor and depreciation on construction machinery, those costs are
debited to this account. WIP and the billings account are not removed from the balance
sheet until the contract is completed under both the completed contract and
percentage of completion methods.
 • Prepaid expenses - These are costs such as prepaid rent that have been paid but not
expensed yet. Financial Analyst says that prepaid expenses should be classified as
noncurrent on the theory that they don’t convert to cash.
• Deposits - See above account on advances to suppliers which this account could also
represent. If the account is large and its nature is uncertain, ask about it because its
placement affects cash flow and if it doesn’t relate to inventory or fixed assets, its
recoverability could be questionable.
• “Other” assets - Details should be requested if the amount is large. It could be anything.
Depending on the nature of these assets, consider spreading them as noncurrent.

Noncurrent assets
• Property (land), plant (buildings) and equipment - The three accounts should be broken
down, if possible, because we see some very high balances for land and buildings. For a
manufacturing company, equipment used in the manufacturing process, if detailed,
should be disclosed separately so we can compare the purchase of new equipment that
we’re asked to support to existing equipment. Accumulated depreciation should also be
shown in the spread.
• Leased assets - If you see them on the balance sheet, this means a capital lease as
opposed to an operating lease. The depreciation rate is based on the useful life of the
asset because ownership normally transfers to the lessee at the end of the lease.
• Deferred charges - By definition they are prepaid expenses that won’t be recognized
within one year and should be rare. The most often seen deferred charge is organization
costs (legal and other fees to start a business).
• Goodwill- Goodwill is an intangible asset. it can only be created through a consolidation -
but not a combination - process and only with a purchase. Goodwill arises when a
company acquires another entire business. The amount of goodwill is the cost to
purchase the business minus the fair market value of the tangible assets, the intangible
assets that can be identified, and the liabilities obtained in the purchase.
• Intangible assets - They have no physical presence, represent an economic benefit for a
company or they would be written off, and their useful life can be difficult to determine.
Some intangible assets can be sold including computer software, patents, copyrights,
trademarks and franchise fees. Others like deferred charges, startup costs and leasehold
improvements cannot.

Liabilities
• Current liabilities are those expected to be paid within one year of the balance sheet
date. See also previous comment under current assets on the normal operating cycle of
a business.
• Accounts payable should be listed first because they will probably have a shorter term
than bank debt and other short-term liabilities.
• Bank debt and bank overdraft facilities should be listed next and separately. An overdraft
facility is a financing activity and should be entered in “overdraft/interest-bearing” in
Financial Analyst.
• Accrued expenses - Accrued expenses have been incurred and should be recognized but
haven’t been paid yet. Examples are accrued but unpaid interest and salary/wage
expenses. High balances may mean these expenses aren’t being paid on a timely basis.
• Current portion of long-term debt (CPLTD)- Current Portion of Long-Term Debt (CPLTD) is
the long-term portion of the debt of the company which is payable within the period of
next one year from the date of the balance sheet. These are separated from the long-
term debt on the balance sheet as they are to be paid within next year using the
company’s cash flows or by utilizing its current assets.
• Advances from suppliers - Should be classified as current since they will be settled with
the delivery of inventory unless they’re high value items that won’t be manufactured
and delivered within one year. An advance from an inventory supplier is an operating
activity; for manufacturing equipment it’s a financing activity.
• Lease obligations - As with leased assets, if it’s on the balance sheet, this means it’s a
capital lease. There should be current and non-current portions.
• Notes payable - If the amount is large compared to other liability accounts, find out who
the lender is, a bank, supplier or a shareholder, and so note in the spread, i.e., “note
payable - shareholder.”
• Subordinated debt - Subordinated debt is also known as junior debt or mezzanine debt. It
ranks lower than most other types of debt and securities in terms of claims on the
borrower’s assets. In simple words, we can say that if a borrower defaults or wind off
the business, the lender of the subordinated debt will get the payment only after the
payment is made to all other debt holders. We can also call it a junior debt,
subordinated bond, or subordinated debenture.
• Deferred taxation - It’s done because of tax and financial accounting timing differences
and disclosure is required in the U.S. and by I.A.S. Deferred taxation can be either an
asset or liability account, with the latter being the most common. An example is
straight-line depreciation for financial accounting purposes versus accelerated
depreciation for tax purposes. Accelerated depreciation could result in a current tax
liability of $500, whereas the eventual tax liability based on a straight-line calculation
would be $700. Income tax expense for financial accounting purposes is $700 with the
balance sheet showing $500 due as a current liability and $200 being reported as
deferred.
• Provisions - They could include warranty expense, maintenance expense for a long-lived
fixed asset such as an aircraft engine, or severance benefits. A provision, with the debit
being to an expense account, is required by the matching principle. In theory, there
could be current and noncurrent portions. Another situation which could either be
provisioned or mentioned in a footnote is a pending lawsuit. The lack of a provision
 however is possible even though it might be warranted, because the company would be
tipping its hand on the amount it might be willing to settle for.
• “Other” liabilities, whether current or noncurrent, should be included in a separate
category rather than combined with another account.
 Unearned revenue- This would normally be a current liability. Magazine or newspaper
subscriptions paid in advance are an example.

Stockholders’ equity
• Contributed (also called paid-in) capital should be listed first and consists of the par value
of common stock issued, capital in excess of par value, and donated capital for which no
shares were issued. We rarely see capital in excess of par value or donated capital, so
there will be a single account which should be labeled capital stock.
• Proprietorships and partnerships - Common practice is one equity account labeled
proprietor’s or partners’ capital. For disclosure reasons a separate schedule is prepared
which shows beginning capital, net income, withdrawals, additional capital
contributions and ending capital.
• Retained earnings - These are accumulated earnings net of cash or stock dividends. There
can be appropriated and unappropriated retained earnings. The latter would be rare in
the companies we deal with and, in any event, can be converted back to unappropriated
by the board of directors. If retained earnings doesn’t reconcile from year to year, an
“unexplained adjustment to retained earnings” comment will appear at the bottom of
the income statement spread with the amount. The reasons and amounts should be
determined and entered in a section for that purpose at the bottom of the income
statement. It could be caused by cash or stock dividends, an allocation to legal reserve, a
prior period adjustment (rare), or the prior year’s statements not being adjusted to end-
of-the-second-year equivalents.
• Legal reserve (an appropriated retained earnings account) - It’s required by law in many
countries, is based on a percentage of net income up to a specified limit, and can be
converted to shares.
• Treasury stock - We will rarely see this account, which has a debit balance, in a closely
held company.
• Minority interest - Minority interest is the minority stockholders’ share of the
consolidated assets and liabilities. It will be seen as a liability, between liabilities and
stockholders’ equity or as part of stockholders’ equity. It’s the latter. Minority interest
will also be shown in the income statement.
 “Reserves”- This could be revaluation reserve or appropriated retained earnings for a
specific or no specific purpose. If large, the exact nature should be determined.
Contingent liabilities/off-balance sheet items:
Contingent liabilities should be noted in the spreads. In Moody’s Financial Analyst, they can be
noted in the “Statistics” section.

Income statement:
• Disclosure - There are very few prescribed requirements other than: extraordinary items,
unusual or infrequent items, results of discontinued operations, and the effects of a
change in accounting principle. If the company is engaged in different sales activities and
countries, a breakout is in order.
 Revenue/ Sales- Revenue in accounting refers to the entire amount of money made
through selling products and services from a company’s core operations. Revenue is
another word for businesses’ income, sometimes called sales or turnover.  
• Cost of goods sold (which includes cost of goods manufactured for a manufacturing
company) - COGS consists of direct material, direct labor and indirect manufacturing
costs (factory overhead) with the latter being primarily depreciation expense on
manufacturing equipment.
• Selling, general and administrative expenses (SG&A) are those normal, ongoing,
operating expenses that are necessary to run a business which can be included in a
single line item.
• Depreciation expense - For a wholesaler or a retailer, it’s an operating expense. For a
manufacturer it’s both an operating expense and part of CGS, but a breakdown is rarely
given, so it should be reported in the spread as part of CGS because most of it will be a
manufacturing expense.
• “Other” income and expense - Spread below operating income.
• Gains or losses on sale of fixed assets- These should also be spread below operating
income as extraordinary income due to non- recurring in nature and one time of gains
or losses. Such items should be added back to EBITDA while calculating the cash flow of
the business.
• Interest expense - Sometimes it’s reported net of interest income. Interest expense and
income should be spread separately.

• Extraordinary items - Also spread below operating income. To be considered extraordinary, a

transaction or event must be both unusual and of infrequent occurrence considering the
environment in which the company operates.
• Deferred taxation - Proper disclosure would show income tax expense broken down into
the amounts currently due and deferred. This topic is further discussed in the liability
section.
Statement of cash flows:
Since this statement is generated by Moody’s Financial Analyst and most other spreading
software, a discussion of the three components of the statement is in order. Investing activities
consist primarily of the acquisition and disposal of property, plant and equipment and to a
lesser extent loans and long-term investments. Financing activities include loans from unrelated
parties, additional contributed capital and dividends. Operating activities are defined as all
other activities not specifically defined as investing or financing activities, or more specifically
those activities and accounts that involve the primary operations of a company which would be
the production and sale of goods and services, principally inventory, receivables, trade
payables, and wages and salaries.
With high quality audited statements, the assumption is that the cash from operations figure is
accurate. One of the most important comments in this entire paper is compare the software-
generated cash flow figure to the figure in the original statement of cash flows. Also, the
software just picks up the changes that it sees in the balance sheet, so stock dividends,
revaluations of fixed assets, and fixed assets acquired with debt will not be correctly reported in
the software-generated statement. Adjustments and changes in the spreads can and should be
made so that the software generated
statement is the same or almost the same as the original statement. In some cases,
adjustments may not be possible, so certain items will need to be noted manually in the spread
or mentioned in the narrative. Also, the software gives you flexibility over which line item you
place an account, so a financing activity might incorrectly be shown in the statement as an
operating activity. See “General comments,” item F at the beginning of this memo to determine
which activity will be affected by an account. Differences in the two figures may further be
explained by reviewing relevant footnotes and the statement of changes in stockholders’ equity
assuming there is one.