Did you ever wonder why your banker asks for three years of financial statements when you begin a credit relationship with them? Do they really look at all this information? (yeah, they really do)
Banks do something called trend analysis. Trends for a banker are the changes in liquidity, leverage, profitability or activity (how quickly they are turning receivables or inventory is activity) over a period of time.
One year of financials have nothing to compare. There are no trends. Two years are considered a coincidence. Maybe a change happens between the two years, but will it happen again? Three years is considered a trend by bankers. The reason for that is the change happened not once, but twice.
For example, if your gross profit margin went from 30% year 1 to 25% in year 2 to 20% in year three, that's a trend. Bankers will do this trend analysis on an annual basis when they do the annual review of your line of credit or mortgage or other term loans. Trends can be positive or negative and both are reviewed. The reason they are reviewed is because the bank wants to know if the risk of lending to your company has changed either positively or negatively. They are required to assign a risk rating to your loans every year.
I suggest getting on the same page with your banker by doing your own trend analysis and find out what your bank might be thinking. What do you think?
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Thanks, Bill, for the cogent explanation, which you've always been good at. I now have something to show my clients when I ask for their financials. Credit and financials are having an increasing impact on getting good insurance; risk involves more than lightning striking. To get good insurance, you need to show that you're a good risk and finances are a part of that. Frank Humphreys, Hamby and Aloisio
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