Limitations on Facts Disclosed by Balance Sheets

In this article, we will discuss limitations on facts disclosed by balance sheets. A balance sheet may be looked upon as an aid to the assessment of a banking proposition. It is, however, not safe to presume that there is a set formula for drawing business conclusions or calculating lending risks from a study of balance sheets. While the figures in the balance sheet disclose broad trends, they do not themselves answer all questions.

Limitations on facts disclosed by balance sheets

For example, the production of a manufacturing concern may fall due to labor strike or non-availability of raw materials, due to transport bottleneck or it may be due to some unhealthy competition which may not last long but it should not be considered a decline in the efficiency or profitability of the concern.

It is, therefore, essential that the bank should go beyond the financial data and make further inquiries regarding the causes of any variation or abnormal trend noted in analyzing the data.

It must be realized that a balance sheet is a static analysis of the company’s affairs on a particular date. There may, thus, be a temptation of window dressing on the part of unscrupulous management. They may inflate the value of the assets raw materials, finished goods, stores, spare parts, etc. to give a better picture of the company’s financial position.

Any meaningful interpretation of these statements will depend upon the projection of the future trend. Past events are just guides as to what may reasonably be expected to occur in the future.

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