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Imputation Of Missing Company Financial Ratios: Bridging the Gap of Missing Company Financials to Estimate Credit Risk

November 24, 2015   //   By Giorgio Baldassarri and Alma Chen

One of the biggest challenges faced by analysts assessing credit risk of a large portfolio of counterparties is the lack or incompleteness of company financials. This issue is particularly common in the case of private companies, because they are usually not subject to the same strict accounting standards as their public counterparts and thus may not report some common financials; notable in this sense is the omission of cash flow items, that are not required from small and/or medium private companies in some countries [1-2], unless the company follows the International Financial Reporting Standards (“IFRS”) reporting standard [3].

However, even public entities may sometimes recognize and report specific items at different times, or omit them altogether, if they follow different accounting standards; for example, in the Income Statement reported under IFRS, “extraordinary items” are prohibited, while they are defined and may be reported (even if infrequently) under US Generally Accepted Accounting Principles (“US GAAP”); other cases include the way leases, financial liabilities and equity may be differently classified under IFRS and under US GAAP. [4]

Missing financials can hinder proper risk assessment by the analyst, for example by inhibiting generation of outputs from a quantitative model, that uses those items as statistically significant variables for discriminating good from bad companies. This also affects the coverage of any prescored database that collects outputs (scores and/or probability of defaults) calculated from a credit risk model using a database of company financials such as S&P Capital IQ®.

 

[1] For Finland: “Doing Business in Finland”, UHY (November 2013, from www.tietoakseli.fi\en).
[2] For India: http://legally.hubpages.com/hub/Companies-Act-2013-and-its-implications-on-Private-Sector.
[3] For a review of permitted/required use of IFRS standards in 150+ countries, worldwide, see: http://www.iasplus.com/en-gb/resources/ifrs-topics/use-of-ifrs (Deloitte).
[4] “IFRS and US GAAP: similarities and differences”, PwC (October 2014).

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