Warren Buffett really hates complex financial modeling when analyzing investments and you should, too, when making credit decisions.

This past weekend at Berkshire Hathaway's annual meeting, dubbed the "Woodstock of Capitalism," Buffett asserted that "there is so much that's false and nutty in modern investment banking that, if you just reduced the nonsense, that's a goal that you should reasonably hope for."

"If you need to use a computer or calculator to make the calcuation, you shouldn't buy it," he added. In credit, you might say, we don't actually "buy" things. But in a way, we do. And the decision process ought to be viewed the same way, because every time we extend credit to a customer, we're, in a very real way, "investing" in them.

Added Buffett's partner Charlie Munger, "Some of the worst business decisions I've ever seen are those with future projections and discounts back. It seems like the higher mathematics with more false precision should help you, but it doesn't. They teach that in business schools because, well, they've got to do something."

And our favorite line from their "anti-math" comments was Buffett's, "If you stand up in front of a business class and say a bird in the hand is worth two in the bush, you won't get tenure..."

The same advice holds true for credit decisions. Predicting insolvencies and coming problems usually comes down to the basics and you don't need to be a financial genius to get the basic trend. And that can be summed up with:

Based on their business model and what you know about their market, will they run out of cash to pay the bills? If so, when?

Simple as that.

Now, we know it's not always quite so simple. We operate in an imperfect world, and rarely have complete information. But whenever possible, those two questions are the sum total of what your credit analysis should be attempting to answer.

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Buffett book, March 29, 2010

By marcroft - See all my comments

For those of you who enjoy biographies, I recommend The Snowball - Warren Buffett and the Business of Life by Alice Schroeder (check your local library). It's entertaining and gives you a glimpse inside his head.

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