Bad debts

Finance companies are in the debt business - so a soundly managed one will tell you upfront how good they are at chasing up bad loans. Sending the repo man around is one option if all else fails, but it's not a good solution for anyone.

A prospectus should list three types of bad debts. In the jargon of investment land, these are:

• impaired assets
• past due assets
• bad and doubtful debts.

What bad debts tells you is that the company has some doubts about the quality of these parts of its assets.

Where to find the information

Information about debts can be found in the Notes to the financial statements section of the prospectus.

An easy assessment of a company's assets can be quickly carried out by looking at the Statement of financial position. Divide the total liabilities by total assets - if the answer is more than one, the company has more debts than assets.

One of the finance companies we looked at had net receivables (money it receives in loan payments) of $110 million in 2006 - but it had $3.2 million worth of past due loans. This was way over a prudent limit of 2 percent of receivables. It was able to sell those loans for $250,000 to another company and so write them off from their accounts. Its doubtful debt provision for next year is a smidge over $2 million - up from $650,000 the year before.

According to The Independent, another finance company had lent a massive $191 million of investors' money - mainly in residential housing - but managed a profit of only $591,132 for year ended September 2005. The 2006 accounts show the company has over $17.2 million in past due assets.

Our tip

Divide the total liabilities by total assets to find out if the company has more debts than assets. Past due assets shouldn't be much more than 2 percent of the net income the finance company receives from loan repayments.