{"id":1082,"date":"2023-10-02T17:51:25","date_gmt":"2023-10-02T15:51:25","guid":{"rendered":"https:\/\/creditanalyst.eu\/?p=1082"},"modified":"2023-10-02T17:51:27","modified_gmt":"2023-10-02T15:51:27","slug":"advances-how-to-treat-them-in-financial-statements-analysis","status":"publish","type":"post","link":"https:\/\/kurtovicfinancial.com\/en\/advances-how-to-treat-them-in-financial-statements-analysis\/","title":{"rendered":"ADVANCES <\/strong>\u2013 How to treat them in financial statements analysis<\/strong>"},"content":{"rendered":"\n

Advances <\/strong>received are a fantastic source of financing \u2013 interest-free and received prior to the provision of services or delivering products.<\/strong><\/p>\n\n\n\n

Many companies rely on them to finance their operations. This is most common in specialized high-value manufacturing industries, engineering, and construction businesses.<\/p>\n\n\n\n

By receiving advance payments, companies are able to finance their working capital on the back of their customers instead of paying interest on bank debt.<\/p>\n\n\n\n

How to treat advances in fin. statements analysis?<\/strong><\/p>\n\n\n\n

When companies have large amounts of advances received and\/or given, this often blurs the view on actual liquidity.<\/p>\n\n\n\n

For example, the normally very useful (Cash + Available credit lines) \/ short-term debt ratio becomes less valuable because it does not register that the actual cash on balance comes from advances, which, by the way, may have already been spent.<\/p>\n\n\n\n

In essence, advances received are a liability, and should be treated as such.<\/strong> If things go wrong, the company may need to return the money received.<\/p>\n\n\n\n

It is also important to net advances received with advances given<\/strong>, because many companies channel the part of the advance payments to their subcontractors.<\/p>\n\n\n\n

Are all advances received made equal?<\/strong><\/p>\n\n\n\n

No, not all advances are made equal from the cash flow perspective.<\/strong><\/p>\n\n\n\n

Normally, most advances fall into the category of working capital <\/strong>because they are received within the regular course of business to finance operations.<\/p>\n\n\n\n

But advances given for Capex should be reported under Capex<\/strong>, and not under the working capital section of the cash flow statement.<\/p>\n\n\n\n

Also, in case a company received an advance payment from financing source like an EU fund, it should be treated as a financing cash flow.<\/strong><\/p>\n\n\n\n

So, these things have to be clearly segregated, although they are often summarized under the same line in a balance sheet.<\/p>\n\n\n\n

What are the most common practical pitfalls?<\/strong><\/p>\n\n\n\n

The most common practical pitfalls I have seen are the improper allocation to working capital instead of to Capex or financing, and not excluding them from the actual liquidity.<\/strong><\/p>\n\n\n\n

However, the BIGGEST pitfall is a psychological one.<\/strong><\/p>\n\n\n\n

Companies with large advances received tend to ignore the fact that the actual high amount of cash comes from advances, which are liabilities.<\/strong><\/p>\n\n\n\n

And this often gives decision-makers a false sense of sufficient liquidity.<\/strong><\/p>\n\n\n\n

A company with high net advances received is doing fine when sales are growing, but when the trend turns, suddenly there may not be enough cash.<\/p>\n\n\n\n

Add a pinch of a high fixed cost base, and things go wrong pretty quickly\u2026<\/p>\n\n\n\n

________<\/p>\n\n\n\n

Advances are a great source of financing, but special care needs to be given when this becomes a source your company cannot function without.<\/p>\n\n\n\n

This is where a cash flow \/ planning kicks in.<\/p>\n\n\n\n

________<\/p>\n\n\n\n

CreditAnalyst(.eu) Credit Risk Management | Debt Advisory | Financial Planning<\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"

Advances received are a fantastic source of financing \u2013 interest-free and received prior to the provision of services or delivering products. Many companies rely on them [\u2026]<\/span><\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[19,22],"tags":[187,133,47,59,29],"class_list":["post-1082","post","type-post","status-publish","format-standard","hentry","category-credit-guide-2","category-credit-insights","tag-advances","tag-cash-flow","tag-credit-analysis-2","tag-financial-statements-analysis","tag-working-capital-management"],"_links":{"self":[{"href":"https:\/\/kurtovicfinancial.com\/en\/wp-json\/wp\/v2\/posts\/1082","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/kurtovicfinancial.com\/en\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/kurtovicfinancial.com\/en\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/kurtovicfinancial.com\/en\/wp-json\/wp\/v2\/users\/4"}],"replies":[{"embeddable":true,"href":"https:\/\/kurtovicfinancial.com\/en\/wp-json\/wp\/v2\/comments?post=1082"}],"version-history":[{"count":1,"href":"https:\/\/kurtovicfinancial.com\/en\/wp-json\/wp\/v2\/posts\/1082\/revisions"}],"predecessor-version":[{"id":1083,"href":"https:\/\/kurtovicfinancial.com\/en\/wp-json\/wp\/v2\/posts\/1082\/revisions\/1083"}],"wp:attachment":[{"href":"https:\/\/kurtovicfinancial.com\/en\/wp-json\/wp\/v2\/media?parent=1082"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/kurtovicfinancial.com\/en\/wp-json\/wp\/v2\/categories?post=1082"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/kurtovicfinancial.com\/en\/wp-json\/wp\/v2\/tags?post=1082"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}