Credit Checking - How to Read Micro or Short Form Accounts

Small company accounts filed at Companies House only show short form or micro balance sheets but that is all you need to check credit worthiness.

What to Look for in Short Form Accounts

Companies House website carries copies of all filed UK company accounts. The vast majority of these are SME's where only truncated (short form) balance sheet details are disclosed.

However short form accounts will contain everything that is needed to indicate the degree of risk attached to either selling to a company on open credit or advancing any other form of loan.

To begin with, this is what a balance sheet you can obtain from Companies House might look like.

Fixed Assets   15,500
Current Assets 93,250  
Creditors due within 1 year (88,500)  
Net Current Assets / (Liabilities)   4,750
Creditors due after 1 year (6,250)  
Net Assets   14,000
Capital & Reserves / Equity   14,000

Working Capital; Current Ratio

Net Current Assets calculated as current assets less current liabilities represents the working capital of any business. They also broadly define liquidity.

This is by far the most important number for credit control: For example when planning your business for the year ahead, a balance sheet forecast showing positive working capital means that your company is likely to be good for the money.

It is in fact a far more important indicator of solvency than positive net assets / equity especially when these include a significant value for fixed assets.

Increased borrowings will improve cash but not liquidity. Because liquidity is generated solely from core trading activities the risks remain: Borrowings only represent a short term remedy not a cure.

Reading Balance Sheet Solvency

The specimen balance sheet working capital of 4,750 indicates short term liquidity and the prospect of positive cash flow. 

It is however possible for a company to be showing a deficit for net current assets but very large equity / net worth. Don't allow yourself to be fooled by this.

Point one is that fixed assets are never intended to be cash convertible and point two is that their depreciated net book value usually does not represent anything like fair resale prices. Those values only represent their residual useful working life, which will be very much lower than a "fair value" if they were to be put up for sale. They might even have zero cash value.

Fixed Assets of Zero Cash Value

Some fixed assets such as "improvements to leasehold properties" as part of equity / net worth are worthless in cash terms. This is because the improvements revert to the benefit of the landlord upon the termination of the lease.

Items such as improvements are never intended to be cash convertible and in case even if they do carry some value it is likely to be only a fraction of their written down net book value.

When assessing a balance sheet for credit worthiness, net current assets (working capital) is the only way to go.

Fixed Asset to Net worth Ratio

There is a fixed asset ratio which can be used to define the safety of fixed assets vis-a-vis net worth

To calculate the fixed asset / net worth ratio, simply divide total fixed assets by net worth. The perceived wisdom is that up to 0.75 is reasonable. However it is working capital alone that rules the roost where liquidity is concerned, whatever the fixed asset ratio is telling you. 

Late Filing of Company Accounts

Apart from the annual accounts, Companies House also lists the dates upon which the next filings are due and notes to advise where filings are overdue. There can be many reasons why filings are overdue - None of them good.

Managing your Balance Sheet

For any SME there's a lot more to a strong net current assets position and a fixed asset / net worth ratios of 0.75 or less than accounting technicalities.

These really are the keys to ensure that a healthy balance of cash and cash convertible assets are always available so that a business can pay its bills on time. Failure to do so inevitably leads to insolvency and the only safe way to avoid that is to properly plan and forecast profits, liquidity and cash flows.

Forecasting and Planning Liquidity with Figurewizard

Follow the links below (especially for the interactive What-If calculator to see how Figurewizard enables you to do this online, quickly and easily just using your estimated figures for sales, margins, overheads and investment. You simply enter your forecast figures and we do the rest.

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