The future of financial analysis: How GPT-4 is disrupting the industry
Researchers from the University of Chicago have demonstrated that large language models (LLMs) can conduct financial statement analysis with accuracy rivaling and even surpassing that of professional analysts. The findings, published in a working paper titled “Financial Statement Analysis with Large Language Models,” could have major implications for the future of financial analysis and decision-making.
The researchers tested the performance of GPT-4, a state-of-the-art LLM developed by OpenAI, on the task of analyzing corporate financial statements to predict future earnings growth. Remarkably, even when provided only with standardized, anonymized balance sheets, and income statements devoid of any textual context, GPT-4 was able to outperform human analysts.
“We find that the prediction accuracy of the LLM is on par with the performance of a narrowly trained state-of-the-art ML model,” the authors write. “LLM prediction does not stem from its training memory. Instead, we find that the LLM generates useful narrative insights about a company’s future performance.”
Chain-of-thought prompts emulate human analyst reasoning
A key innovation was the use of “chain-of-thought” prompts that guided GPT-4 to emulate the analytical process of a financial analyst, identifying trends, computing ratios, and synthesizing the information to form a prediction. This enhanced version of GPT-4 achieved a 60% accuracy in predicting the direction of future earnings, notably higher than the 53-57% range of human analyst forecasts.
“Taken together, our results suggest that LLMs may take a central role in decision-making,” the researchers conclude. They note that the LLM’s advantage likely stems from its vast knowledge base and ability to recognize patterns and business concepts, allowing it to perform intuitive reasoning even with incomplete information.
The findings are all the more remarkable given that numerical analysis has traditionally been a challenge for language models. “One of the most challenging domains for a language model is the numerical domain, where the model needs to carry out computations, perform human-like interpretations, and make complex judgments,” said Alex Kim, one of the study’s co-authors. “While LLMs are effective at textual tasks, their understanding of numbers typically comes from the narrative context and they lack deep numerical reasoning or the flexibility of a human mind.”
Some experts caution that the “ANN” model used as a benchmark in the study may not represent the state-of-the-art in quantitative finance. “That ANN benchmark is nowhere near state of the art,” commented one practitioner on the Hacker News forum. “People didn’t stop working on this in 1989 — they realized they can make lots of money doing it and do it privately.”
Nevertheless, the ability of a general-purpose language model to match the performance of specialized ML models and exceed human experts points to the disruptive potential of LLMs in the financial domain. The authors have also created an interactive web application to showcase GPT-4’s capabilities for curious readers, though they caution that its accuracy should be independently verified.
As AI continues its rapid advance, the role of the financial analyst may be the next to be transformed. While human expertise and judgment are unlikely to be fully replaced anytime soon, powerful tools like GPT-4 could greatly augment and streamline the work of analysts, potentially reshaping the field of financial statement analysis in the years to come.
Ex-IRS Officer and Brother Sentenced for Stealing Millions in COVID-19 Relief Funds
A former IRS officer and his brother have been sentenced to prison for their role in a multi-million dollar scheme to steal COVID-19 relief funds, according to a DOJ press release.
Key Points:
Frank Mosley (58) and Reginald Mosley (60) were sentenced to 30 and 12 months in prison, respectively.
The brothers obtained over $3 million in fraudulent Paycheck Protection Program (PPP) loans.
They achieved this by inflating payroll figures and using a company name they didn't own.
Four others were charged for aiding the scheme by allowing the Mosleys to use their businesses for loan applications, receiving a 15% cut in return.
Frank Mosley, a former IRS revenue officer, is accused of using his expertise to cover up the crime.
Pandemic Relief Funds Abused
Prosecutors allege that the Mosley brothers, along with their co-conspirators, exploited the PPP program designed to aid struggling businesses during the COVID-19 pandemic. The brothers submitted fraudulent loan applications in 2020 and 2021, inflating employee numbers and payroll costs for their own company, Forward Thinking Investors Inc. This resulted in them receiving over $1 million in relief funds.
Their scheme didn't stop there. The Mosleys then recruited three other individuals to submit additional fraudulent applications using their legitimate businesses. In exchange for their participation, the co-conspirators were promised a 15% share of the fraudulently obtained funds. A sixth defendant is accused of aiding the Mosleys and others with their fraudulent applications and securing nearly $300,000 in relief funds under a company name she wasn't affiliated with.
All Six Plead Guilty
The two brothers and the four other defendants, Marcus Wilborn, 50, of Elk Grove; Aaron Boren, 56, of Roseville; Scott Conway, 52, of Rocklin; and Kenya Ellis, 55, of Los Angeles, involved in the scheme pleaded guilty to their respective charges. The Mosley brothers received the harshest sentences due to the severity of their crimes and Frank Mosley's prior position with the IRS. The remaining defendants received sentences ranging from 12 to 18 months in prison.
IRS Reiterates Commitment to Accountability
The IRS emphasized its commitment to pursuing those who abuse the financial system, particularly during times of crisis. "No one is above the law," stated IRS-CI Acting Special Agent in Charge Michael Mosley (no relation). This case serves as a reminder that even those entrusted with upholding financial regulations can be held accountable for their actions.
PayPal sees YoY drop in receivables purchased; refrains from 'merchant cash advance' terminology
The recent earnings report from PayPal reveals a few interesting stories about the companies' lending and working capital offerings and how they describe them in their earnings calls versus what's on their financial statements. The drop in receivables is certainly a focus but we also want to discuss why they keep the word merchant cash advance out of reports.
Paypal's Merchant Receivables and Lending Products
Paypal's 10-Q filing provides insights into the company's Merchant Receivables segment, including its PayPal Working Capital (PPWC) and PayPal Business Loan (PPBL) products. In the quarter ending March 2024, it's reported that PayPal purchased $419 million of receivables, however in the same quarter of 2023 it was $666 million, a large 37% drop. They didn't explain why this was and I did not uncover their expectations for the future but one thing I know is there are more business financing products out there than ever before so origination is a fierce battle.
The PayPal Working Capital product allows merchants to borrow a certain percentage of their annual payment volume processed by PayPal, with a fixed fee charged based on the merchant's credit assessment. Repayment is made through a fixed percentage of the merchant's future payment volume processed by PayPal.
So in other words this is a merchant cash advance but Paypal and many other companies use this different terminology because of the negative connotations associated with the term with its history of high cost and predatory lending business practices. PayPal uses the word 'advance' on its financial statements but refrains as much as possible when speaking publically about the product given the negative connotations.
Source: PayPal 10-Q Filing
Webank is the bank behind the PPWC but PayPal does all servicing. PayPal can classify and market the PPWC as a loan on their website but also as Working Capital which leads to them even defining what working capital is in their FAQs.
"Generally, working capital is the difference between your business's assets and liabilities. Businesses use working capital to run their business and pay for everyday expenses as well as invest in new projects and initiatives".
Working capital is described by most as the 'usage of funds', not a type of loan. However, the term working capital has become popular to substitute for the term merchant cash advance or revenue based financing so that customers aren't scared away.
It's important to point this out because most mainstream media misses or ignores this information when they discuss MCAs. Let’s point out that there are tiers to the MCA/Revenue Based Financing market. PayPal is in the top tier and then we categorize funders in a middle and a low tier.
It is the low end where most of the problems are but the public needs to be informed that these top-tier companies are offering the same product helping thousands of businesses gain access to billions in capital every year so they aren't pushed away from the product overall.
Beyond the top tier, there are dozens if not hundreds of direct funding companies that operate successful businesses with reasonable cost offerings given the risk that help small businesses gain the capital they need.
Lastly, on PayPal earnings, they reported that in 2023, its gross charge-offs for these lending products declined to $38 million, down from $228 million in 2022.
SBA Lender and Development Company Loan Programs (SOP 50 10 7.1)
See the original SOP here
The document titled "SOP 50 10 7.1 effective 11.15.23.pdf" is the Standard Operating Procedure (SOP) 50 10 7.1 issued by the U.S. Small Business Administration (SBA) for its Lender and Development Company Loan Programs. This SOP, authorized by Kathryn Frost, the Acting Associate Administrator for Capital Access, came into effect on November 15, 2023. It serves as an update to the previous version, SOP 50 10 7, and outlines the policies and procedures governing the 7(a) and 504 loan programs offered by the SBA.
The SOP is divided into three main sections:
- **Section A: Core Requirements for all 7(a) and 504 Loans** - This section provides the foundational requirements applicable to both 7(a) and 504 loan programs. It includes chapters on primary applicant eligibility requirements, credit availability, special transaction structures, uses of proceeds, and ethical considerations, among others.
- **Section B: 7(a) Loan Program Specific Requirements** - This section delves into the specifics of the 7(a) loan program, detailing the requirements for standard 7(a) loans, 7(a) small and SBA Express loans, 7(a) CAPLines, 7(a) Export Trade Finance, and the E-Tran terms and conditions through disbursement for all 7(a) loans.
- **Section C: 504 Loan Program Specific Requirements** - This section focuses on the 504 loan program, covering eligibility through the submission of applications, SBA E-Tran terms and conditions through disbursement, and debenture pricing and funding.
The SOP emphasizes the importance of SBA Lenders and Certified Development Companies (CDCs) starting their review process with the core requirements outlined in Section A. It also highlights the necessity for SBA Lenders to comply with the detailed guidance provided for each delivery method in the applicable chapters of Section B and C.
Significant updates in this version include the introduction of SBA’s Risk Mitigation Framework for determining applicant eligibility, the use of technology to validate applicant data, and the emphasis on real-time validation of program eligibility to protect against fraud and ineligibility. The document also specifies the conditions under which SBA Lenders can request exceptions to policy and the procedures for such requests.
Appendices at the end of the SOP provide additional resources, including forms, acronyms, definitions, and specific requirements for environmentally sensitive industries and gas station loans.
This SOP is a comprehensive guide for SBA employees and SBA Lenders, ensuring that they adhere to the updated policies and procedures for the effective and efficient administration of the 7(a) and 504 loan programs[1].
Need a Loan for Your New Small Business?
Get the one that is right for you
Small business owners typically need to borrow money to buy equipment and supplies, pay employees, and otherwise finance their operations. To help you get a loan that fits your needs, these are some basics to consider on your road to success.
Apply now!
Improve your chances of getting a good loan
Start by having a well-prepared business plan. Showing proposed earnings can reassure lenders that a loan will be repaid.
Maintain a good business and personal credit history
Manage your business and personal credit well to increase the likelihood of being approved for a loan when you need it. A good credit score and history suggests to banks and other financial institutions that you have handled your finances well, and it can help you qualify for better loan terms, which helps save you money. For more information on credit reports and credit scores, visit FDIC Consumer News: Credit Reports and Credit Scores.
Apply now!
Monitor your credit report for accuracy
An accurate credit history is important to building and maintaining good credit. Many criteria go into a credit score, including your payment history and the number and type of loans that you have. Monitoring your credit report can help you ensure that the information is accurate, and if not, then you can take steps to correct it in a timely manner. Monitoring your credit report will also help you guard against identity theft, scams, and avoid unexpected credit issues when you go to apply for a loan. For more information on monitoring your credit and scams targeting small businesses, visit FDIC Consumer News: Your Small Business Deserves Big Support.
Comparison shop for government-guaranteed loans
The U.S. Small Business Administration (SBA) has several programs to help finance small business loans. SB Finance is a leading provider of all types of SBA loans.
Apply now!
Many SBA loan programs combine business coaching and technical assistance, as well as access to financing, on more flexible terms. One example is the 7 (a) Loan Program, SBA’s most widely-used loan guarantee program. The specific terms of SBA 7(a) loans are negotiated between the borrower and the participating lender, subject to the requirements of the SBA. According to the SBA, the 7(a) loan is often the best option when real estate is part of a business purchase, but it can also be used for: short- and long-term working capital, refinance current business debt, or to purchase furniture, fixtures, and supplies.
Such loans may have minimum dollar amounts, however, so if you need a loan for less than the lender’s minimum amount, ask your bank for a referral to a lender participating in the SBA Microloan Program. According to the SBA, its Microloan program provides small businesses with small, short-term loans — up to $50,000 — for working capital, or to buy inventory, supplies, furniture, fixtures, machinery, and equipment. Such loans are only available from specially designated intermediary lenders, which are non-profit organizations with experience in lending and technical assistance.
Apply now!
Understand the different types of financing
For most small businesses, operations are financed in three key ways (not including investments or loans from family and friends):
Personal lines of credit are commonly used, such as credit cards (either an owner’s personal card or a business card guaranteed by the owner) or home equity lines of credit (the small business owner’s home serves as the collateral), but there are risks.
A personal credit card is convenient, but it can be an expensive financing tool. Owners using a credit card may quickly find themselves taking on debt that cannot be reasonably supported by projected revenues from the business.
With home equity lines of credit, one problem is the potential loss of your home if you are unable to repay funds as agreed. Another problem with home equity lines is that in certain situations, banks can suspend access to a line or reduce the credit limit. For example, if the value of your home declines significantly below the appraised value, or if the bank reasonably believes you will be unable to make payments because of a drastic change in your financial circumstances, the bank may suspend your credit.
Business lines of credit provide a convenient way for a business to borrow up to a certain dollar amount and repay it in installments with interest over several years. Business owners should consider how and when the business will generate revenue to repay the loan. Short-term financing tools should not finance costly, long-term investments.
Business term loans, which establish a set dollar amount repaid in installments over three or more years, are recommended for purposes such as financing the purchase of equipment or a vehicle. Often, the asset that is purchased secures these loans. Term loans mean predictable payments for businesses, but unlike lines of credit, a business may have to make a new application if it needs to borrow additional funds.
Apply now!
Protect your personal accounts
Keeping your business accounts separate from your personal accounts has some benefits.
All deposits owned by a corporation, partnership, or unincorporated association at the same bank are added together and insured up to $250,000, separately from the personal accounts of the owners or members.
Business banking offers limited personal liability protection by keeping your business funds separate from your personal funds.
The separation makes it safe and easy to authorize employees to handle day-to-day business banking tasks without being involved in your personal finances.
The Internal Revenue Service also recommends that you have a business checking account that is separate from your personal accounts because doing so can make recordkeeping for tax time easier. It may even be essential, depending on your corporate structure.
Business accounts can help establish convenient ways for customers to pay with credit cards or use checks made out to your business.
The need for separate accounts generally increases as a business grows or becomes complex. Just remember, consumer protection rules do not apply to transactions conducted by a business, whether it be a deposit account or loan.
Small business owners need to know what financing is available and what works best for them to be able to grow their businesses, and have the right resources to make their business a success.