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Sarah Asks:

"I am assisting a client and have come across a paragraph in the CPA-compiled financial statements that references 'tax basis.' The terminology is confusing. Could you provide some clarification on this?"

Linda Says:

As a credit analyst, when you come across the term "tax basis" in CPA compilations, it's important to understand its relevance to your analysis. The tax basis refers to the method of accounting that the financial statements are prepared under, which is based on the tax laws and regulations. Here's why it matters to you:

1. Tax Compliance and Reporting: The tax basis financial statements are designed to reflect income and expenses as they will be reported on the tax return. This can help you assess the company's tax compliance and potential tax liabilities.

2. Differences from GAAP: Tax basis financial statements can differ significantly from those prepared under Generally Accepted Accounting Principles (GAAP). As a credit analyst, you should be aware of these differences, as they can affect the analysis of a borrower's financial condition.

3. Loan Covenants: If loan covenants are based on financial ratios or other metrics derived from financial statements, it's crucial to know whether these are GAAP or tax basis figures. The basis used can impact covenant calculations and compliance.

4. Cash Flows: Since tax basis accounting often aligns more closely with cash transactions, it can provide insights into a company's cash flow, which is a critical factor in credit analysis and loan decision-making.

5. Understanding the Business: Analyzing tax basis financial statements can give you a clearer picture of how tax strategies are impacting the business's finances and operations.

Remember, as a credit analyst, your goal is to evaluate the creditworthiness of borrowers. Understanding the accounting basis of financial statements is key to making informed lending decisions. If you need further clarification on tax basis financial statements, consider reaching out to a CPA or utilizing resources that explain the differences between tax basis and other accounting methods.

Got a Question? Send it to us at experts@lendersonlinetraining.com and have your question answered by one of our Credit Analyst Experts.

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