July 2008

Is your company fit enough to survive an economic downturn?

Alistair DarlingIn The Times on 19th July 2008 the Chancellor, Alistair Darling, gave his gloomiest assessment yet of the state of the British economy. He warned that the downturn was far more profound than he had thought and could last for years rather than months. This article led Stephen Smith to recall the events of 1991 and 1992 and look at the uncertain future for the economy.

I suspect the Government back in 1991 feared the effects that an economic downturn would have on their chances of a fourth consecutive victory at the ballot box. The then Prime Minister, John Major and senior members of the Cabinet consistently fended off suggestions that the UK was going into recession and they were returned to power on 9 April 1992. Probably the reality was that prior to the election the economy was already in a deep recession. This was then followed by the events on 16th September of that year when his Chancellor, Norman Lamont, stood outside the Treasury and, after a crazy day on the currency markets, announced that the Government was suspending Britain's membership of the European Exchange Rate Mechanism.

UK Training was established in 1982 and is a well financed organisation and it survived those turbulent times - many of our competitors did not. Sixteen years on UK companies are left contemplating what will be the effects of another period of economic uncertainty. By contrast, this time it would appear that we are being prepared for the worst. We should all take a rain check and scrutinise our company's Balance Sheet. There are many features of a Balance Sheet that clearly explain to the trained eye whether a company is financially viable or not. If your company is profitable don't be complacent. There are many organisations that trade profitably but still have a disastrous cash flow situation.

What should you look at when examining a Balance Sheet? My first port of call is to look at the Current Assets and Current Liabilities and hopefully find that the Current Assets exceed the Current Liabilities. If they don't, and there are Net Current Liabilities, then the alarm bells start to ring. I then concern myself about Gearing and examine the relationship between the Shareholders Worth and the extent of any long-term borrowings. If the company is highly geared, that is the long-term borrowings are disproportionately high to the Shareholders Worth, then my anxiety grows. It is too easy for some companies to react to a worsening cash flow situation and raise long-term loans only to find that a once profitable organisation is now showing little return for its shareholders because the trading profits are barely covering the interest charges on the loans.

All directors need to understand their company's Balance Sheet and satisfy themselves that the company is capable of meeting its financial liabilities. To trust this to somebody else is a risk. Your board needs to jointly and severally be of the opinion that the company is solvent. If, as a director, you blissfully carry on in ignorance because you do not understand all the features of a Balance Sheet then you run the risk of being liable for the company's debts.

I urge all directors to make sure that they understand their company's Balance Sheet and how to Manage Cash Flow. I have asked my colleague Roger Mason, who is an expert in finance and company law, to spend 3 hours with you to explain how you can master these skills. For details of this training session please click here.


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