How To Analyse Debts And Liabilities

Published in Investing on 30 September 2009

Here's a company struggling to meet its short-term financial obligations.

After investigating, last week, the pension fund deficit at BT Group (LSE: BT-A) by digging into the notes to the most recent set of company reports, today I'm having a look at one of the biggest millstones around company necks these days, staying afloat despite debt and short-term liabilities.

As if to serve our purpose, news last week from Blacks Leisure Group (LSE: BSLA) told us that, for the six months ended 31 August, the company failed to maintain its obligations to its banks (in tech speak, it is in breach of its banking covenants).

So with that bad news in the open, I went looking for the Blacks annual report for the year ending 28 February 2009, to see if I could find any pointers to the current trouble. You can get a copy of it from the company web site, here (though you do have to enter some minimal personal details).

Beware pretty pictures

The first thing that struck me is that the first chunk of the report is packed with colourful photos of happy families enjoying the outdoor life, which I find immediately suspicious, as that's a tactic that is often used to disguise bad news. But that's an aside, so let's get straight to the actual reports...

Firstly, if we look at the Income Statement on page 35 (using the printed, not the PDF index, page numbers), we first see that Blacks made a bottom line loss for the year of £14.7m, including exceptional costs of £7.6m, and net finance costs of £2.3m (£3.9m paid in finance costs versus £1.6m earned in income).

If we then check the Balance Sheet on page 38, we see bank overdrafts totalling £5.3m, and an imbalance between trade and other payables of £36.4m against receivables of £10.5m. That already looks like a company struggling that may be struggling to pay its way -- and the net cash outflow of £3.9m that we can see from the Cash Flow Statement on page 39 doesn't help.

The notes

We see notes 24 to 27 referenced against some of the Balance Sheet liability figures, so let's skip to those and try to put some more flesh on the bones.

Note 24 (on page 62) confirms the overdraft figure, but with the revelation that the sum is payable on demand, and that Blacks is paying about 6.5% interest on it -- that's not a healthy state to be running a business in, especially as banks are exceptionally twitchy about their debtors these days.

Note 25 shows us that £1.3m in finance leases will have to be paid during the next year, with a further £2.5m in the following 4 years (though at least the total is down from the previous year).

On to page 63 and note 26, where we see a breakdown of the company's liabilities in respect of short term trading cash that it owes. A total of £36.4m is owed, for goods and services that the company has acquired but not yet paid for, utilising the usual kind of credit arrangements that most businesses do. With the average credit period being 47 days and bearing no interest, for a company operating healthily that would be good -- it is getting £26m more in interest-free short-term credit from its suppliers than it is allowing its customers. But if a company is struggling to meet its outgoing obligations, this is a liability that its banks might not look too kindly on.

Now, note 27, on the same page, looks quite scary. If we check back to note 8, on page 51, we'll see an explanation of Blacks' need to get out of onerous leases for a number of loss-making high street stores, mainly under the Millets brand, and which has led to the exceptional costs that we have seen. We also read that high street trading conditions are worsening, and that that has led to further exceptional costs for the continuing lease-exit programme.

So back to note 27, where we see a breakdown of the provisions made for the ongoing store closures and lease exits, leading to liabilities at the end of 2009 of nearly £4.9m due in the following 12 months, with a further £8.2m due after that.

Our conclusion?

So, overall, what we see by examining Blacks' financial statements and notes to the accounts, is a company that is struggling with a severe downturn in its markets, but which is saddled with expensive long-term leases for shops in which it is losing money. And getting out of those leases is going to take a lot more of the cash that it hasn't got, so it's really not that surprising that the company's banks aren't deliriously happy.

This is, of course, all hindsight, but I think we really could have seen the current problems coming. If we perhaps couldn't predict an actual breach of banking covenants, we would surely have seen that there was a significant risk that the flow of cash was going to dry up.

Oh, and I haven't read any of the 34 pages that precede the financial statements. I'll leave that as an exercise for the reader -- it might be interesting compare our analysis here with the picture that the directors paint in the waffly bits.

More Investing Basics from Alan Oscroft:

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