As an increasing number of firms indicate high levels of financial distress, business asset prices are being undermined and look set to collapse.
The economy is grinding to a halt, leading to an oversupply of assets with no willing buyers. On top of this, a sharp reduction in the number of transactions has made valuations more subjective and vulnerable to inflation. With the Covid-19 crisis, the current inability to undertake in-person valuations further exacerbates the problem.
Deloitte has issued a warning over the increased risk of fraud in property valuations. The Royal Institution of Chartered Surveyors has issued a valuation practice alert to notify members of the impact of these extraordinary circumstances and advise on the use of material uncertainty clauses in valuations.
In this article we look at this issue in more detail, analysing what the implications of this collapse could be and how you can protect yourself.
In the next few months, it is expected that a large number of businesses will fail and the asset values on their balance sheets will collapse, raising only a fraction of their book value. This is for two reasons: not only have auditors accepted overly inflated asset values in company accounts in recent years, but asset prices will be severely depressed as the market is flooded with unwanted business assets.
Take, for example, the expensive fitted kitchens of the many expected insolvent bars and restaurants. New restaurants will not be springing up to replace them any time soon, so those kitchens are unlikely to fetch much more than their scrap value.
This means that balance sheets, in many cases, are not reflective of companies’ net worth. When they fail there will be little or nothing to be raised from their asset sales, meaning that creditors will be left with little or no dividend being paid out by insolvency practitioners.
As a result, it’s more important than ever to keep an eye on your customers. Take a closer look at their balance sheets and see if there is something there that doesn’t look quite right. You may want to consider tightening your payment schedules or taking other measures to reduce credit risk.
Companies with strong balance sheets raising a fraction of their stated asset values are nothing new, with multiple examples over the past few years. What will make things worse is the collapse in demand for these assets from the flood of supply that is expected. This could lead to an unprecedented fall in asset prices.
Fashion retailer Blux Limited (trading as House of Hanover Ltd) went into liquidation in 2016 owing £25.1 million to nine unsecured creditors, including £15.8 million to NH Finance. The balance sheet showed assets valued to cover the majority of these debts. However, the liquidated statement of affairs showed assets of £17.75 million and is expected to realise just £14,000.
When Jamie’s Italian – Jamie Oliver’s casual dining chain – went under in 2019, the 275 unsecured creditors were left with losses of £6.7 million. Secured creditor HSBC is no better off, looking set to lose nearly £40m. Once again we see how the book value of assets evaporates in an insolvency, with £29.9 million of assets subject to a floating charge that is only expected to realise £400,000.
Paper product manufacturers Arjo Wiggins (Wiggins Teape) was once listed on the London Stock Exchange and used to be part of the FTSE 100 index. However, when it went bust 420 unsecured creditors lost over £14 million. This was despite balance sheet assets of over £123 million, which are expected to raise just £20 million.
Given the current climate, it is now essential to be aware of your customers’ finances and dig a little deeper into their balance sheets to consider what their assets might actually be worth.
At Red Flag Alert, we’re always evolving our algorithm to look deeper into the financial health of a company. If companies are inflating asset prices or there is a trend in disposals bringing in less cash, we tweak our algorithm to include that information. As well as our algorithm, we also have experts collating, analysing and digesting data to generate financial health ratings that accurately predict insolvency.
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