Risk and Financial Management: Preparing a Balance Sheet

 

Risk and Financial Management: Preparing a Balance Sheet

In today’s discussion, we’ll explore the concept of a balance sheet and its implications for financial management. Let’s analyze a case study where a company’s details are provided, and we’ll prepare a balance sheet while addressing liquidity, solvency, and strategies for improvement.

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Case Details (in £k):

• House constructed but unsold: 2,190
• Stock of materials: 342
• Bank account and cash in hand: 121
• Accounts payable (creditors): 702
• Accounts receivable (debtors): 76
• Provision for future guarantee claims: 90
• Land purchase for long-term development: 1,160
• Management fee owed to parent company: 65
• Plant and machinery: 1,950
• Loan from parent company: 4,700
• Bank overdraft: 167
• Deposits received from yet-to-complete house buyers: 68

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Balance Sheet Preparation

Fixed Assets

• Land purchase: £1,160
• Plant and machinery: £1,950
• Total Fixed Assets: £3,110

Current Assets

• Cash in hand: £121
• Accounts receivable: £76
• Stock of materials: £342
• House constructed but unsold: £2,190
• Total Current Assets: £2,729

Current Liabilities

• Bank overdraft: £167
• Accounts payable: £702
• Management fee owed: £65
• Deposits received: £68
• Total Current Liabilities: £1,002

Long-Term Liabilities

• Loan from parent company: £4,700
• Provision for future guarantee claims: £90
• Total Long-Term Liabilities: £4,790

Financial Metrics

Liquidity:

• Net Liquidity = Current Assets - Current Liabilities
  = £2,729 - £1,002 = £1,727
• This indicates the company has £1,727k in readily available funds to meet its short-term obligations, reflecting good liquidity.

Net Assets (Equity):

• Net Assets = (Fixed Assets + Current Assets) - (Current Liabilities + Long-Term Liabilities)
  = (£3,110 + £2,729) - (£1,002 + £4,790)
  = £5,839 - £5,792 = £47k
• The company is solvent but has slim net assets, heavily dependent on its parent company’s financial support.

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Scenario Analysis: Subsidiary Sale and Loan Write-Down

To enhance financial stability, the company decides to sell the subsidiary, eliminating loans and claims from the parent company. Let’s recalculate the balance sheet:

Adjusted Current Liabilities

• Remove the management fee: £1,002k - £65k = £937k

Adjusted Long-Term Liabilities

• Remove the parent company loan: £4,790k - £4,700k = £90k

Revised Liquidity

• Liquidity = Current Assets - Adjusted Current Liabilities
  = £2,729k - £937k = £1,792k

Revised Total Liabilities

• Adjusted liabilities = £937k (current) + £90k (long-term) = £1,027k

Revised Net Assets

• Total Assets = £5,839k (unchanged as cash or physical assets remain the same).
• Net Assets = Total Assets - Adjusted Total Liabilities
  = £5,839k - £1,027k = £4,812k

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Key Insights and Implications

1. Improved Liquidity:
   The removal of the management fee increases liquidity by £65k, providing more resources to meet short-term obligations.

2. Strengthened Solvency:
   Without the parent company loan, the balance sheet reflects stronger equity of £4,812k, showing reduced dependency.

3. Minimum Sale Price:
   To avoid future losses, the subsidiary must sell for at least £4,812k, covering total net assets.

4. Goodwill Considerations for the Buyer:
   If the sale value exceeds net assets (£4,812k), the excess is recorded as goodwill on the buyer’s balance sheet. Goodwill represents the intangible value of the company, including its brand, customer relationships, and future earning potential.

• Example: If the subsidiary sells for £5,000k, goodwill = £5,000k - £4,812k = £188k.
• Goodwill is included as an intangible asset on the buyer’s balance sheet.

Pooja Mattapalli

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