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How to Use Customer Tax Returns in a Credit Review

When your customer is missing financial statements, you can prequalify them with a tax return instead. Wondering how you can use this process today? 

Join this upcoming webinar to find out! D’Ann Johnson, Credit and Collections Manager for A-Core Concrete Cutting, will provide the ins and outs of using tax returns to review credit, determine financial risk, and set credit limits.

Register for the live discussion and Q&A to find out:

  • Why tax returns can be just as effective as financial statements
  • How to read the different tax returns that can help make credit decisions
  • Reliable strategies for developing strong credit reviews


Lori J. Drake, CBA (00:01):
Good afternoon, everybody. And thank you for taking time out of your busy schedules to join us today. As we talk about how to use a customer’s tax return in a credit review, uh, today’s going to be presented by Dan Johnson. She has a credit. Oh, I think that got updated. She’s what they core concrete cutting. And she has the corporate credit manager or credit manager. She’ll still give us that when she introduces herself, go ahead and change it. Okay. Uh, if you don’t know who Levelset is, we know that the construction industry is very confusing. So we try to develop ways to take away the headache that you have dealing with it. We have software to help you with liens and webinars or excuse me, lanes and waivers. We have a community now with payment professionals where you can ask questions and get answers. So you can get 10 events and webinars and kind of share your information with other people throughout the industry. And as I said, there we go, corporate credit manager. This is Dan Johnson. Dan, thanks for joining us today. Your beach has me.

D’Ann Johnson (03:46):
You want to go ahead and introduce yourself? Yeah, just to clarify, I am not at the beach, but I wish I was. Um, but Kim, my name’s DeAnn Johnson CCM, the corporate credit manager for ACOR concrete. Cutting. Uh, we are located from Texas to Oregon. We have 13 diff in 13, different states, nine different divisions and seven different companies somehow or another. We’re all under one umbrella, but it all filters into one. Um, I’ve actually, as it says, I worked in credit management for over 20 years. Um, the majority of that is in the construction industry previously, I worked for Ken were sales, the big trucks. Um, prior to that, I have worked in government. I’ve worked in private, uh, facilities, uh, medical field. So I’ve kind of got a myriad of experience that gives me the ability to look at businesses from all aspects.

D’Ann Johnson (04:47):
Um, I do have my CCE and my MBA, and I’ve served on several industry trade groups as well as set on the, um, lean. And guys probably don’t know what I’m talking about week, but in Utah we have what we call the state construction registry, which is a government oversight seen website where you can go in and log your pre-lease and leans on projects that are being done in the state of Utah. So I’ve sat on the board for that to make improvements, to get that started. Um, and then I’ve also said on the lean recovery board, which in the state of Utah, we had a foundation that the state funded that if a lien was filed against a homeowner and then the homeowner needed had kids show proof that they had already paid the lien, the lien recovery fund would go in and make us whole, or the, the, uh, supplier holes.

D’Ann Johnson (05:49):
So again, I, I’ve kind of done a lot of little different things. Um, I just want to clarify something for you guys as having been in construction as the majority of you probably know financial statements are few and far between in the construction industry. Um, most construction companies are privately held, getting financial statements out of them is an art. Um, I do know people that are have been successful with that. Uh, I don’t see financial statements on a regular basis. We currently do. The majority of our work is under government contract. So with that, this is, um, some information on how you can use a tax return as a financial statement. So for today, we’re going to look at some comparison ratios as we go through this, you may find others that would be a benefit to your business. And again, this is dependent on the type of business you do as to whether the numbers work for you or not.

D’Ann Johnson (06:52):
Um, if you’re selling to a restaurant and you’re selling food, your needs, and what you’re looking at is completely different than somebody who is putting roof roofing shingles on top of a roof for a home builder, right? So let’s get into it. So first we’re going to look at the 10 40 schedule C, uh, and then the 10 65 and 1120 as income statements. And then we’re gonna look at the 10 65 and 1120 is rudimentary balance statements. So, uh, the 10 40 C is a basic income statement. Line one is revenue line four is the cost of goods. Line seven is gross. Margin line 28 is operating expense and line 31 is net income. With this information, you would be able to perform common size analysis. And this example, cost of goods sold is 57% of the total. What would that indicate about this business?

D’Ann Johnson (07:53):
Again, that depends on the business you’re doing with them operating expenses 28, is that good or bad again, depending on the industry you’re in and what you’re selling, that might be a great number, or that might be a number that is not in your comfort zone. Also remember it’s best to have two or more, um, if you can get them tax returns or financial statements to do a trend analysis, uh, you can kind of base some information off of, off of this, off of what you’re seeing here, but you’d really want more to show the last two to three years.

D’Ann Johnson (08:35):
So let’s move on to current assets. So in this slide, we are looking at, uh, sorry, excuse me, allergies promise. So this is page five from form 10 65, and you can see up your page five and will allow you to calculate current ratio for liquidity. In this example, by adding lines, one D 2d, 3d 40 and 60, you have a term total current asset amount of $65,846 adding lines, 15 D 16 and 17 B you have a total current liability of $27,461. Current ratio is calculated by dividing the current assets of the 65,000 by the current liabilities, which is the 27,000 with the result of 2.4. Why is this important? If you’re short short-term creditor, which we most, most, all of us are liquidity measures, short term solvency. So in this example, 2.4 suggests that there is $2 and 40 cents in current assets for every dollar of current debt. That’s a good sign. However, a high current ratio is not necessarily good if the business lets receivables age out or in the case of a supplier to turn the inventory slower, the current ratio will go up while operations deteriorate.

D’Ann Johnson (10:11):
So, and this next slide that I’m showing you, this is just the, um, Excel spreadsheet showing how that is all calculated. And if anybody wants this information, please let me know. I’m happy to share on this next slide. We’re going to look at current assets. So we’re still on page five of form 10 65. So in here, we’re going to calculate the quicker acid ratio. This as this ratio is more stringent mesh, sorry, this ratio is a more stringent measure of liquidity than current ratio as it deducts and the inventory. Why? Because it’s an asset inventory is the least liquid, depending on the inventory, it may be high dollar or especially items that have liquidated might be so at a discounted or files by yourself, price that would reduce his value as an asset. In this case, all calculations are identical to the previous slide, with the exception that we subtract or don’t add line 3d for inventory. This gives us a new ratio of 0.68. This suggests that this company should have the ability ability to pay off short-term debt, but may have to work out some payment arrangements without having to liquidate some inventory.

D’Ann Johnson (11:36):
And again, next slide is just every other slide, just so you guys know is the, um, Excel spreadsheet breakdown. So the next slide we’re gonna look at is, um, again, we’re still using page five form 10 65. Everything’s the same, but now we’re calculating working capital. Working capital is the amount the business uses in its day-to-day operations. And this example, this company has working capital of 38,385. Is that good? Again, it depends on what you’re selling, right? If they have working capital of 38,000 and you’re selling them large ticket items, that might not be what you’re looking for, that might not be what you need. Right? So again, Excel spreadsheet. Um, the next slide we’re going to look at is going to be, and we’re still again using form five of 10 65, the same lines as the previous slide. Hold on just a second.

D’Ann Johnson (12:47):
Let me, sorry. Nope. This is a different, yep. I gotta look here looking. This is a, uh, different little bit different slide. Wait a minute, let me catch up here. Um, now we are adding a page. That’s what it is. So we’re still using page five. This is page five. Um, but we’re adding page one from 10 65. This way we can calculate the average collection period from this example. So here we have their net AR divided by their net sales divided by 365 equals 15.7. So that’s their average collection period. That’s how often they turn their cash. So is that good?

D’Ann Johnson (13:37):
Again, depends on the business you’re doing right. So let’s move on to it against XL spreadsheet. Um, as you can tell, I’m big on Excel spreadsheets because they keep my brain and where it needs to be. Um, so now we’re gonna switch things up. We’re gonna start now using the 1120 form and by using line three, which shows an amount of 68,000 to 36 and dividing it by the total of line one C, which is $215,600. We show this company has a gross profit margin of 40%. That basically means that 40 cents out of every dollar for this company, they can use to pay down debt or invest back into the company. That’s not bad, right? That’s not bad.

D’Ann Johnson (14:29):
So again, we will move on to Excel spreadsheet. I’m clicking the wrong right button would be nice just then we’re going to move on to again, still, um, 1120, and we’re okay. We can calculate the net profit margin as a presenter. So in this example, again, we’re still using the same form. We have line one C right? Are we sorry? We have line 30, which is 17,080 for net profit before tax. And we’re dividing it by line one C, which is net sales, which is 7.9%. That’s almost an 8% profit net profit margin. That’s, that’s pretty good. So now again, we’re going to move on to Excel spreadsheet and we’re still sticking with, um, 1120.

D’Ann Johnson (15:39):
And on this, we are calculating net earnings after tax. So again, we’re using much of the same formula as we did last on the previous slide. This time though, we are subtracting line 31, which is the total tax pay that gives us a net profit after tax of 4.36. That’s kind of a drastic change, right? Um, so this might indicate that this customer might be heavy in inventory that they’re having to pay taxes on every year or, um, you know, some other things that maybe their, their tax rate that they pay in their state is higher than what would be in another, um, type of, of industry. And again, this is just the Excel spreadsheet. So I know it’s kind of quick, it’s kind of down and dirty, but, um, so that leaves us to the end of my little presentation. Do you, is there any questions that I can try and answer?

Speaker 3 (16:49):
You’re on mute Laurie? Oh, there we go. Sorry. I was trying to stay

Lori J. Drake, CBA (16:55):
Quiet while you were talking. I thank you for that. That was a lot of information. Uh, if anybody has any questions, please go ahead and add them in the chat channel and we’ll get the math answered right now. I do have some that came in early. One is from Joe. What do you say to the customer to get them, to give you their tax documents?

D’Ann Johnson (17:16):
That’s a good question. Um, my understanding about five, maybe six years ago, there was some push to make tax documents, public record. Um, and again, you know, that, that hasn’t happened. All you can do is ask because if you don’t ask, you don’t get an answer and the worst they can tell you is no, there are other ways to find this information of publicly trading companies. You know, we all know you can get those financial it’s when you come to the private companies or the small entrepreneur, who’s doing business, maybe out of the cab of his truck. And you ask him for financial statements and he hands you a box of receipts in there. Um, sometimes this is easier. And when you’re dealing with some of these type of businesses, they may be a little bit more open to giving you access to these. Uh, especially if you let them know, you may have to sign some sort of a confidentiality agreement or a non-disclosure agreement, uh, and reiterating that this is simply for a basis of establishing commercial credit.

D’Ann Johnson (18:34):
This information will not be shared or given to anyone else other than you or your credit analyst, whomever, you’ve decided that we’ll handle this and that, you know, once you are done with making your decision, these documents will be shredded. Sometimes it’s just making the customer comfortable with what you’re going to do with this information. Same thing. If you asked for a personal guarantee, um, how many times have you asked for a personal guarantee and they’ll sign a personal guarantee, but they don’t give you their social security number and they push back and say, well, why would I give you my social security number? It’s kind of along the same line.

Lori J. Drake, CBA (19:15):
I completely agree. All right. We’ve got another question from Robin. Do you feel tax documents are any more reliable than financials?

D’Ann Johnson (19:25):
Well, yeah, my, in my perspective, yes, because financial statements have be, I don’t want to say the word doctor, but they can be, they can be made to look a lot better because they put a lot of fluff in there, right? They put a lot of, um, this is the reason why we’re doing this. This is a reason why we sold this off. This is tax statements are more black and white. Um, can they be, can the numbers be fudged? Of course, any numbers can be fudged, right? In any numbers can be budged, but you’re more likely to get a truer sense of the company’s financial dealings with a tax statement than you are from a financial statement that is being put together by some company that, like I said, puts it in a nice, shiny slicker with all of the information on the company. And, but that’s just my perspective.

Lori J. Drake, CBA (20:25):
I agree with that. If you’re going to turn in documents to the state, you’re, you’re in more trouble than they would just be with us, trying to give them credit. Right. Right. Let’s see. Next question is from Amy. Do you get a lot of pushback when you request texts, documents?

D’Ann Johnson (20:42):
Um, you know, Amy, I’ll be honest with you. Um, because of the, of what we do, as I said at the beginning, most of our projects are government. So there’s a contract. It comes, I’ve never really had to ask for, uh, a tax document since I’ve been with ACOR. When I was with my previous company, which was a roofing supplier roofing material supplier, um, I actually did ask for a couple of tax documents, but it was from people we had done business with for a long time. So the relationship was already there. The trust was already there. I’m not negating that. It wouldn’t be difficult to ask, but again, if you never ask, you never get an answer.

Lori J. Drake, CBA (21:32):
All right, next question is from Mary. How did you figure this out?

D’Ann Johnson (21:39):
Well, and I’m going to be honest with you guys. Um, I’ve been when I first started into commercial credit and as deep as I’ve gotten, um, I had a mentor that we were talking one day about, I was taking my financial statement analysis class, and I asked the question, well, you know, because I was working for a roofing material supplier, most of my leg is that most of my guys said, if you want their financial statement, here’s a shoe box with receipts. You figure it out. Right? So I said, well, what if they don’t have a financial statement? And he looked at me, says, funny, you should ask that you can use tax documents as financial statements. And we started talking and this kind of evolved from that. So, um, I’m on, I, I run this back by a couple of CPAs who were surprised.

D’Ann Johnson (22:39):
I was surprised that they didn’t know you could do this. I’m not saying all CPAs didn’t know that they, that you could do this, but they were surprised. They’re like, well, I never thought of it that way. So, um, it w it was just kind of a happy accident. Me not, and I will be honest me not understanding when I first took financial statement analysis, what I was looking for and why this helped clarify solidify in my mind, what I was looking for and why I was looking for it. So that’s how this came about.

Lori J. Drake, CBA (23:10):
Yeah. I’d never heard of this before. I think it’s very impressive. Uh, next, next question comes from Valerie. What other avenues can you use to find? What other avenues can you use to find the tech stocks, if they don’t want to provide them to you,

D’Ann Johnson (23:26):
Valerie. Unfortunately right now, tax documentation documents and tax documentation are still considered private information. You are, I guess, in a way bound by the ability or the willingness of your customer to share that information with you. Um, and you’re going to get pushback. You’re going to get people that say no, but at the end of the day, if you go back to them, and this is just my experience, and this goes with financial statements, tax statements, personal guarantees. If you go back to the customer and you lay your cards on the table and say, you know, I’m sorry, Mr. Customer, we would really love to do business with you, but much like a bank. We have to have supporting documents. We are, we are lending you money. And my job is to make sure that not only my company, but you are protected. So if, if I can’t have access to these documents, I’m unable to, to help you with this account, we could offer you a cash account or a Cod account, but unfortunately we can’t offer you an open account.

D’Ann Johnson (24:33):
It would be the same as if you walked into a car dealership and expected them to hand you the keys to a brand new truck and walk off the lot with it, without them doing any, you know, backup information. So again, you can ask, they can say, no, you can negotiate. There’s always room for negotiation, worst case scenario. Um, I’ve actually had people send me and I hate to say this, and I don’t know why they wouldn’t send me tax information, but they sent me the bank statements. So I think I would rather send somebody my tax information than my bank statement, but that’s just me.

Lori J. Drake, CBA (25:11):
Uh, because like Bradley asked, do you, I’m trying to read, do you ever go back after an account is open and asked for tax certificates? And if you do, why

D’Ann Johnson (25:24):
There’s many reasons why you should go back on and ask for any documentation. If you have a customer, maybe you’ve done business with them three months. Maybe you’ve done business with them six years, but you see a slowing trend. You see an uptake in the business that they’re bringing to you. Anything that, that makes you stop and go, Hm. Why you asked for the backup documents and you can justify it that way. You can say, you know, Mr. Customer, we are so grateful that you are now coming to us for so much more, but in order for me to satisfy the needs of our bank, I need more information from you. So could you provide me with financial statements, tax returns or, you know, even worst case scenario, personal guarantee. Um, I’ve actually had companies that I’ve gone back. We’ve done business with them for five, six years, and all of a sudden they are quadrupling their business with us.

D’Ann Johnson (26:29):
Well, my natural curiosity as a credit person is I want to know why. So my first call to them is, you know, thank you. We so appreciate the business. Um, but I need to bolster. We’ve already established for you. So can you help me out with some supporting documents? And then I might reach out to trade references and see why are they all of a sudden coming to us? Or is it something, you know, we all like to think, and I, and I’m going to say this cause I love salespeople. I used to do sales. So I love salespeople. Um, salespeople think that our customers come to them because they love them. Right? We all know that the that’s kind of a little gray area. A lot of times when we see a customer that’s only used a sporadically or for small amounts, all, and all of a sudden they quadrupled or tripled their amount with it is because most likely they’ve been put on hold with another creditor.

D’Ann Johnson (27:28):
That’s something you want to know, because if you are a part of a trade group, you can reach out to that creditor and ask, no. So what’s going on? Is it a D is it actually a dispute? Was there a problem with the specific project? Um, you know, and I’m not saying it’s always the creditor and I’m not saying it’s always the customer. Sometimes it’s the lack of communication. But again, ask the question and don’t be afraid to ask the question. You are the steward of your companies and most cases, largest asset, at least the second largest asset and your Alliance should be with protecting that asset so that you and everyone else that works for your company takes home a paycheck. And that’s a responsibility I take very, very seriously.

Lori J. Drake, CBA (28:21):
Thank you for all that looks like we got one from Beau had to join a boat. If you can’t get more than one year of a tax return, what can you learn off just the one year that you have, if you’re in construction that would tell you if this customer is a good credit risk or not.

D’Ann Johnson (28:38):
So, again, as we noticed, as we looked at the other for construction, particularly most of us are short-term lenders. Um, there’s probably people on the call that are more long-term lenders. Maybe they do equipment leasing and purchase, um, things that, uh, for the most part construction is short term, right? 30 to 60 days, 90 days at most. So you can actually tell enough off of one tax return to make a judgment to assess at. And I, I’m going to use this word and I’m going to throw you guys, I’ll do character. We use the word credit guide, not credit limit. So in our world, we set a credit guide of X amount of dollars based off of not just their tax return, but for, um, credit information, I’ve pulled, you know, we, we are members of NACM. So we pull credit reports through NACM. I will reach out to trade references that they’ve listed.

D’Ann Johnson (29:43):
Um, I will do Google searches and see if there’s something on there that tells me, you know, better business bureau or maybe there’s a, um, Facebook is another great one where you can look up people, rate companies on Google. People will post about companies on Facebook, social media. Um, so that combined with one tax return should give you enough information, knowing that you’re only going to be financing 30, 60, 90 days, that would make it viable for you to move forward. So, and I want to clarify before somebody asks the reason why we used the word credit guide rather than limit. Um, and this is something I learned ages ago, the way the law is federal law is written. And when you use the word credit limit, it specifies an amount. So if you allow your customer to go over that amount, then in, well, legally, they aren’t responsible for that amount.

D’Ann Johnson (30:55):
We use the word credit guide because that allows us to be more flexible. So if I said, let’s say I set a guide for a customer for a hundred thousand dollars, but they have a huge project come in. That’s $350,000. We’re still okay with the letter of the law. And that came to me from an attorney when I first started into this, um, John rhe, I guess second, third, fifth, whatever reincarnation of my career. Um, it’s all about the verbiage and it’s all about the wording. And when you talk to your customers, do you use a credit limit or credit guide? Make sure you say credit guide. Um, so I just wanted to give that brief explanation. No, I appreciate that. Um, I don’t see any more questions, so we’ll thank you. DeAnn don’t log off yet wants to talk more. Um, but thank you for taking your time out.

D’Ann Johnson (31:52):
This is definitely a lot of information. We’ve had several people ask for the presentation so they can perfect it, the numbers more. So we’ll share that out as well. If you’ll go to the next slide. One thing we like to tell people is about Thea Dudley. She is known as the credit overlord. We do have a credit management course that is on our website that you can get certified for. It’s about things like four different sections, eight different sections in each of those. I mean, it’s very short amounts of time, so you can take it at your own pace, but you could get certified for that. I do have a little book thing going on right now that I just put in chat. If you want to try and win a book, a copy of the as new book, a guide to credit and collections, go ahead and download.

D’Ann Johnson (32:35):
You’ll fill in the blank. Go ahead and download first. I think it’s 11 to 15 pages. If you like it, email me your thoughts on the first few pages. And tell me if you would like a copy of the book or not, then we’ll go from there. Okay. Go ahead and do the next one quaking in the wrong box or you’re fine. There’s Dan’s information. You can email her directly. If you have any more questions. I know someone was asking about your Excel. You always kept saying there was an Excel. So I know that’s not in the side show, but if you can share that, you know, some people were requesting that as well. Awesome. Thank you. Be sure to watch your email right after this webinar, you’ll get a short quiz, answer that, turn it in. We’ll get you certified for taking this course. And again, thank you very much for taking your time out. That was some great information that I wish I had back when I had to do all this. Well, thank you for asking. Absolutely. Um, thank you everybody else for coming out and we will see you later. Okay. Have a great day. You too.