Analysing a balance sheet – an insolvency example
As you may know, we can use ratio analysis of financial statements to form a view of how a business is doing. One area worth looking at is liquidity and solvency, which we can for example assess using the current ratio or other working capital ratios.
I came across a great example of a “technically” insolvent organisation recently – none less than the professional body I am a member of, CIMA. Below is an extract from their financial statements of 2016 , but first let me briefly explain what insolvency means. Solvency means a business can pay its debts as they fall due, and technically, if current liabilities exceed current assets, a business is insolvent.
If we take a look at the current assets, the total value of current assets is £18,760,000, whereas current liabilities equals £22,564,000. Thus, technically CIMA is insolvent. What makes this example even more interesting is that if we look at the current liabilities, about £13m is deferred income, the subs in advance. These are already included within the cash balance, or the cash has been spent already, so they are not really a liability per se. However, if CIMA were to close tomorrow, it would have to repay these subs to members. So the cash in the bank more or less could cover this, but then if all receivables were paid they would not cover the payables.
Have a look at the full accounts at the link above if you want to see more.