**U. S Department Of Justice**

**United States Trustee**

***Northern District of Texas, Region 6***

***United States Courthouse***

***1100 Commerce, Room 976***

***Dallas, Texas 75242***

***(214) 767-8967, Fax (214) 767-8971***

**INTRODUCTION TO THE**

**MONTHLY OPERATING REPORT**

**[BACKGROUND]{.underline}**

The enactment of the Bankruptcy Reform Act of 1978 heralded sweeping
changes in the statutory framework governing the administration of
bankruptcy cases in the United States. The years since have witnessed a
continuing series of legislative enactments and rules amendments
designed to further refine and modify the legal requirements governing
this important area. With this focus on statutes and rules, however, it
is easy to lose sight of the simple fact that a bankruptcy filing is
most often precipitated by financial rather than legal problems. In
order to successfully reorganize, a debtor must identify its basic
financial problems, ensure adequate cash flow and develop a feasible
plan to return to profitability based on realistic financial
projections. The monthly operating report forms required by the Office
of the United States Trustee have been designed to assist debtors in
achieving these goals. In addition, the reporting forms provide
creditors with relevant and detailed information regarding the financial
condition of the debtor, whereby facilitating meaningful creditor
participation in the reorganization process. Finally, the reporting
forms provide the United States Trustee with the critical information
necessary to properly perform the statutory oversight and monitoring
function.

A significant amount of time and consideration was devoted to devising a
format for the monthly operating report that would be appropriate for
the majority of businesses. Realizing, however, that it is almost
impossible to design a reporting format that would be an exact match for
every type of business, a certain degree of flexibility and common sense
must be utilized in allowing the debtor to Acustom tailor@ the forms to
his or her particular line of business.

Since the financial reporting requirements in bankruptcy cases differ
from the norm, the monthly operating report forms have been designed to
highlight several specific areas of concern in a chapter 11
reorganization case. A careful review was made of the American Institute
of Certified Public Accountants (AICPA) financial reporting requirements
(SOP 90-7) and the cash flow statements requirements promulgated by the
Financial Accounting Standards Board (FASB 95). While the precise format
recommended by each of these groups was not utilized, elements from each
were incorporated in the monthly operating reports.

The monthly operating report forms package includes a balance sheet, an
income statement, a cash flow statement, and various supporting
schedules that provide additional financial information that highlights
specific areas of concern in a bankruptcy reorganization.

[MOR-1, COMPARATIVE BALANCE SHEET]{.underline}

The simplest way to think of the Comparative Balance Sheet (hereafter
ABalance Sheet@) is as a Astill picture@ of the assets, liabilities and
equity of a business at one precise moment in time. A credit manager
utilizes the balance sheet to determine the financial condition of a
business. A balance sheet reflects the historical cost of assets for a
business. The realizable proceeds from the sale of assets under a
liquidation can vary significantly from the balance sheet values. Many
assets on the balance sheet are valued at their cost to the business,
and this does not necessarily reflect their current fair market values.

The balance sheet is divided into three sections. The first lists all
the assets owned by the business, the second section shows all the
liabilities owed and the final section shows the owner=s equity in the
business. The total of the assets must equal the sum of the liabilities
plus the equity. This is often referred to as the balance sheet
equation:

Total Assets = Total Liabilities + Total Equity

The asset section of the balance sheet is divided into three categories:
current assets, property, plant and equipment and other assets. Current
assets consists of cash and other assets that will be converted into

cash during one operating cycle or one year. The operating cycle of a

business is the basic sequence of producing products, selling those
products, collecting accounts receivable and then converting those
accounts back to cash. Assets that are commonly included on the balance

sheet as current assets include cash, accounts receivable, inventory and
pre-paid expenses.

The second category, property, plant and equipment (fixed assets), is
defined by assets that will be used in the operation of the business
over a period of years. Assets included in this category are land,
buildings, machinery, trucks, office equipment, timber, oil, and gas
properties, computers and other assets. For balance sheet purposes, the
cost of property, plant and equipment (except land) is spread over the
useful life of the asset. The monthly or annual spending of the cost of
fixed assets is known as depreciation. The periodic decrease in the
value of assets, such as timber or oil and gas properties, is called
depletion. In the property, plant and equipment section, the balance
sheet shows the historical cost of the assets minus the accumulated
depreciation or accumulated depletion. The remaining value in the asset
account is termed the net book value. Net book value bears no
relationship to the fair market value of an asset. As a result, the fair
market value of an asset may be more or less than the net book value.
The net book value simply reflects the amount of cost that has not been
carried to the income statement as an expense in the form of
depreciation or depletion. The recognition of depreciation and depletion
expenses are shown on the Income Statement (MOR-2) under the Aother
income and expenses@ section.

The final section of the asset portion of the balance sheet is
designated Aother assets.@ This is the Acatch all@ section for reporting
assets that do not fit within one of the first two categories. Assets
that would commonly be listed in this section include goodwill,
covenants not to compete, investments in subsidiaries or partnerships,
officer receivables and other miscellaneous items. Certain of these
assets are amortized. Amortization is the periodic decrease in value of
an intangible asset. Assets such as goodwill and covenants not to
compete are considered intangible assets because they typically have no
value except to their holder. The costs associated with these assets are
spread over several accounting periods. In each accounting period, a
portion of the total costs is recognized as an expense in the Aother
income and expenses@ section of the Income Statement

(MOR-2).

Depreciation, depletion and amortization are known as Anon-cash
expenses.@ These three items reflect the periodic reduction in the value
of an asset. These are not expenses in the traditional sense, in that
the business does not have to write a check to a creditor each month.
Nevertheless, a reduction in the value of the assets has occurred and
must be recognized for reporting purposes. In the analysis of the cash
flow for a period, these three non-cash expenses (which are recognized
as expenses on the Income Statement) are added back to the net profit
figure when determining the amount of cash generated from operations.

In summary, the three sections of the asset side of the balance sheet
are current assets, property, plant and equipment and other assets.
Added together, these constitute the total assets of a business.

The next section of the balance sheet relates to the liabilities of the
business. Liabilities are the debts owed by the business. Liabilities
can also be thought of as the creditors= claims on the assets of the
business. The liabilities section of a balance sheet ordinarily lists
the debts of a business in two categories: current and long-term.

Current debts are those that must be paid within one year from the date
of the financial statement. Long-term debts are financial obligations
that are due and payable more than one year from the date of the
financial statement.

The traditional breakdown between current and long-term debt has little
value when monitoring the progress of a Chapter 11 debtor. The format
selected for the monthly operating report requires the grouping of
liabilities as pre-petition liabilities and post-petition liabilities.
Pre-petition liabilities are defined as any amount owed prior to filing
bankruptcy, while post-petition liabilities are debts incurred after
filing bankruptcy. Although this method of reporting liabilities is not
in accordance with the AICPA=s SOP 90-7, it serves the same function and
it is believed to be the easiest way for the majority of Chapter 11
debtors to report financial information. This format is also more useful
to parties attempting to monitor the debtor=s compliance with the
requirement of the Bankruptcy Code and the progress toward confirmation.

The final section of the balance sheet is the equity section. There are
many terms that are used to refer to this section of the balance sheet.
Depending on the type of legal entity with which you are dealing, the
equity section might appear as net worth, stockholder=s equity or
partner=s equity. Equity is basically the difference between the value
of the total assets and the amount of the total debt owed. It can also
be thought of as the owner=s claim against the assets of the business.

The equity section of the balance sheet provides a great deal of
historical information relating to the operations and capitalization of
the business. It reflects the owner=s financial investment in the
business and serves as a collecting point for the profits and losses
from the operation of the business. Investments made by the owners of a
business include purchasing stock or contributing additional paid-in
capital. The owners, of course, hope to receive a return on their
investment through such vehicles as dividend payments.

Retained earnings are those corporate earnings which have not been
distributed to the shareholders as a return on their investment, but
instead have been retained by the company to support various corporate
objectives. Retained earnings increased when profits are retained and
decrease when losses are incurred or profits are distributed. Since the
debtor acts as a fiduciary for the benefit of the creditors, the net
profit from the continued operation of a business in Chapter 11 should
be retained. The equity section should increase each month by the amount
of the net profits shown on the Income Statement or only decrease by the
amount of the net loss.

Any report in the equity section (or elsewhere) regarding treasury stock
should always be carefully examined. Treasury stock is stock of the
corporation that is held by the corporation. It includes shares of stock
reacquired by the corporation, as well as authorized but unissued
shares. There are many legitimate reasons for a business to reacquire
its own stock and hold it. However, especially in the context of a
small, privately-held corporation, it is important to have the debtor
explain how the value of the shares was determined and when the money
was paid to the former holder of the stock.

The equity section of the balance sheet is a very important area to
review each month. A simple reconciliation of this section can give the
analyst clues regarding trends in the operation of the business. It can
also show whether the debtor is retaining all profits. The formula to
determine if all profits have been retained is easily applied. Start
with the equity figure from the prior month. Then add (or subtract) the
net profit (or net loss) for the current month. The total should equal
the equity shown for the current month.