Cost balance sheets value assets at purchase price less accumulated depreciation. This accumulated depreciation can be done using tax or management depreciation methods. Management depreciation differs from tax depreciation by using the economic or useful life of the asset for depreciation calculations.
Using cost balance sheets allow lenders to better monitor the financial performance of the business over time. With cost balance sheets, net worth growth comes from business retained earnings. Cost value balance sheets do not have market valuation changes affecting the net worth of the business. Hence true business performance is measured by the cost balance sheet.
Cost balance sheets are not perfect though. Often times the cost value of assets is below the market value, therefore underestimating the solvency position of the business. This will impact credit analysis as you assess the borrowing capacity of the operation and calculate collateral values.
The Best Balance Sheet
Therefore, a best practice may be to complete both a cost and market value balance sheet for customers in FINPACK. You as a lender are then able to best determine retained earnings and the full borrowing capabilities of your customer.