STANDARDS AND FOUNDAMENTALS IN BUSINESS CRISES

STANDARDS AND FOUNDAMENTALS IN BUSINESS CRISES

It is undeniably true that the COVID-19 pushed the global economies into a unexpected “recession” and this must be managed now either from a political and economical point of view cause still, its impact is pretty much unkown.

Though that from a statistical point of view this impact could be measured in term of how macroeconomics variables will be changing and impact the economical landscape.

Smart working for entrepreneurs and advisors is a visible changing paradigm but how businesses will impact on the growth of activities will strictly depend on the use of new technologies.

Looking back to the Banks that produced such a level of financial instability with the same “method” since second world war inward, so that, one should think they will be more and more keen into using smart technologies to monitoring borrower’s financial and credit risk instead of insisting to ignore the adventure of arising and transforming technologies and cryptocurrenies.

This will create an economic society more keen and oriented with compelling smart business information instead of being “slave” of the old economy that has been already transforming into digital.

 

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UNIGIRO -  MONITORING ENTERPRISE CREDIT RISK

The only  XBRL Data Analytics Engine in Europe for monitoring business crisis and preventing financial and credit risks of companies with up to 100 Dynamic Indicators   

Written by dott. Andrea Lupini Chartered Professional Accountant 


 
CORPORATE SOCIAL RESPONSIBILITY: REPORTING FOR SUSTAINABLE DEVELOPMENT

CORPORATE SOCIAL RESPONSIBILITY: REPORTING FOR SUSTAINABLE DEVELOPMENT

Could we expect new developments in the concept of sustainability of enterprises in the light of the COVID-19 era ?  
 
Sustainability is not only linked to the overall debt recorded in the balance sheet under liabilities, but, as is already widely discussed internationally, the company will have to be assessed according to environmental sustainability with Corporate Social Responsibility (CSR) reporting, which has led to go beyond the mere "accounting principles" and accounting standards that are however still very important and necessary for the preparation of a company's economic and financial situation (Financial Statements) and disclosures. 
 
In Europe, the EU Directive 95/2014 transposed by domestic Law among different members sates, it has implied that certain companies shall draw-up a non-financial sustainability statement, as disclosure so that giving a brief description of the company's business model, a description of the policies applied with regard to environmental and social impacts including due diligence procedures applied by supervisory bodies and above all, to provide transparent and non-subjective information on the risks related to these aspects of the company's activities also with reference to its products, commercial services, and relationships that may have negative repercussions, the fundamental indicators of a non-financial nature (but also financial if attributable to them) these obligations fall on companies that have more than 500 employees, to have exceeded at least one of the following size limits: assets exceeding 20 million Euros and/or revenues exceeding 40 million Euros.
 
  
Many European countries in the last few years have already given for sure that environmental sustainability starts from the economic-financial sustainability of a country.
 
The current trend coming up from the United Nations on the "greendeal", shall be more focused on highlighting the fundamental importance of environmental sustainability because financial sustainability is the "of which" of environmental sustainability.
 
In the light of the recent pantdemic COVID-19, should it be the right moment for Authorityes to provide a more compelling disclosure for companies who have interests/participation in the sectors of pharmaceutical and biotechnology ?   
 
At the state of the art, the concept of sustainability is therefore still broad and general and not very well focused sector by sector even though the process of convergency coming from the "greendeal".
 
In fact it is undeniable true that financial sustainability of the debt or indebtnesses (although this concept can be seen in different ways from stakeholders due the level of indebteness taken out by a company and/or a group of companies) might have direct and/or indirect implications and impact on environmental sustainability in a more broad sense, hence the greater and clearer fundamental importance of Corporate Social Responsibility (CSR) reporting shall delivery a common standard to be adopted at global scale.

 

Currently, the Integrated Reporting Framework 1.0 of the International Integrated Reporting (IIRF) and the Sustainability Reporting Guidelines document of the Global Reporting Initiative (GRI) provide the two different approaches to Corporate Social Responsibility.

In short we can see that the standard setting that was suggested in the Integrated Reporting Framework 1.0 provides an illustration of a numerous of information on the relationship between the elements that make up the company and its ability to create value as it is the closest to retracing concepts and corporate finance techniques that are inherent in the concept of capital.


The International Integrated Reporting (IIRF) approach adopts different capital configurations that are periodically increased, reduced or transformed through entrepreneurial activity and the normal course of business. Well, according to this approach- (guideline), the company called to this fulfillment will have to consider in the reporting the following sub-configurations of the total capital-value, and then go to describe in detail the following points:
financial capital: which is composed of all the resources in the form of risk capital and debt capital that can be obtained through the method of reclassifying the balance sheet with the operating criterion; productive capital: which represents the total of fixed or long-term investments, that is, specified by type of capital equipment and multi-year utility (tangible fixed assets);

intangible capital: which is expressed by intangible assets (intangible assets) owned and developed by the company and fundamental for the creation of value;
human capital: which represents the set of skills and knowledge and experiences of the staff who collaborate with the company;
social capital: which represents the complex of relationships developed by the company with stakeholders (stakeholders);
natural capital: which represents the set of all processes, renewable and non-renewable resources that supply the goods used by the company.
 
In conclusion, the recent developments on issues of extreme importance related to environmental sustainability and on the issues of Environmental Social Governance (ESG) that are discussed, a declaration of sustainability as set up may certainly not be sufficient anymore.
Since these issues are hot and important for the balance of the entire global financial system and for Insurance and Banks, also in light of the social emergencies deriving from suspected and dramatic biotechnological wars in progress, the impacts of which at the time of writing are not knowable and not even estimable, it could certainly be the right time to include other types of Indicators in the Company's Financial Reporting that are and will certainly be usable by the ecosystem of Companies and Authorities for risk monitoring, not only credit risks and financial, but also indicators capable of measuring social and environmental risks.

 

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BUSINESS CRISIS: WHAT IS THE ROLE OF ASSET ADEQUACY RATIO ?

BUSINESS CRISIS: WHAT IS THE ROLE OF ASSET ADEQUACY RATIO ?

We would like to point out that here we are only talking about the alert indicator on the company's capital adequacy, which is one of the five "alert indicators" that aim to measure the percentage values that will indicate whether the company is in a crisis situation and therefore risks being reported. 

For all the crisis indicators the alert thresholds are variable according to the sectors of activity in which the enterprises operate and this according to the sector of business.


This means that for all enterprises that will have a given sector of activity the same percentage threshold values exist. For example: Retail trade including BARs and Restaurants the capital adequacy alert indicator is 4.2%. This means that a company operating in that sector (regardless of its organizational and dimensional characteristics) and present a percentage value of 4% will present the value below the threshold and therefore, at the behest of the required information, does not comply with the capital adequacy for that sector with the consequent risk of a "possible" report as the other indicators will also have to present the alert situations sought.

Since we are only talking about an alert indicator or the indicator called "capital adequacy index" it is worthwile to comment in more detailed analysis "first" the concept of "capital adequacy" of the Company, which, as an expression of the 'alert indicator choosen as follow:
 
Capital adequacy index = (NET EQUITY - CREDITS vs MEMBERS - DIVIDENDS) / (DEBTS + PAYABLES AND LIABILITIES) = value %.
 
What does this "capital adequacy ratio" indicator tell us in reality? 
That it is a ratio between two values that can be read from a company's balance sheet under liabilities (capital structure values):

The value of the Adjusted Shareholders' Equity (shareholders' equity - receivables from shareholders - dividends) and the value of Payables (item "Payables" + accrued expenses and deferred income) means first of all that it is a ratio between two values that can be read from a company's balance sheet in the balance sheet among liabilities (balance sheet values).

The numerator indicates the value of "Adjusted shareholders' equity" (adjusted for receivables still owed by the Shareholders to the Company and dividends), while the denominator indicates the value of total "Payables" to which "accrued expenses and deferred income" are added.

The result is expressed in percentage terms and the value indicates the level of the company's structural debt exposure as information aimed at describing the "capital adequacy" of the company operating in the relevant sector, however, as we will see in this review, it is not the only existing indicator to measure the desired capital information on "capital adequacy" even though it is inherent in the structure of a company's liabilities, especially if within the concept of "capital adequacy" all the capital elements and therefore also those relating to the company's structure must be considered.
 
Obviously, as everybody knows, the calculation of this quotient will be lower for low values (or for decreasing variations) at the numerator and/or for high values (or for increasing variations) at the denominator and this reflects the logic of "capital adequacy" wanted in a univocal and transparent way.

Speaking of an "alert indicator" for companies, we are going to analyze in detail the impacts on companies that belong or not to the categories of retail trade, including BARs and restaurants, which in our example must have values above the threshold identified in 4.2%.

At this point it is appropriate to argue other valid scientific, accounting and financial considerations in favour of Companies and Entrepreneurs, which are certainly worthy of interest especially in the concept of "capital adequacy".


It is clear that companies can resort to sources of capital of the company structure through the recourse to shareholder financing, especially when there is a willingness to continue the business activity, however, entrepreneurs will find themselves with financial values entered in the company's coffers (current accounts of the company) that are rightly and correctly accounted for under "Payables to shareholders for loans" and that these values are weighed at the denominator of the indicator.

 It is clear that companies can resort to sources of capital of the company's shareholders through the recourse to shareholder financing, especially when there is the will to continue the business activity, however, entrepreneurs will find themselves with financial values in the company's cash accounts (current accounts of the company) that are rightly and correctly accounted for under "Payables to shareholders for loans" and that these values are weighed at the denominator of the alert indicator in question (the denominator increases and the value of the ratio decreases).

The "shareholders' loan" is a subordinated debt also legally due to article 2467 of the Italian Civil Code that says "shareholders' loan in favour of the Company is subordinated to the satisfaction of the other creditors" therefore remaining an unsecured credit for the Shareholder, for the purposes of "capital adequacy" it will certainly be considered as "risk capital", however this was not provided for by the body appointed to choose the Indicators of the Crisis.

It is clear that this "warning indicator" has some gaps in view of the level of the Company's actual capital adequacy and effective capital adequacy (and therefore in respect of the company's shareholder structure and the voluntary actions taken by the Shareholders of the Company), Therefore, it is certainly worth paying more attention to the result that companies could obtain if their "shareholders' loans" were properly considered as a debt which, by law, being subordinated to all other creditors, is representative of the "capital adequacy" of the company, which in practice is also considered as a book value similar to risk capital.

We have seen that the indicator of "capital adequacy", it values at the denominator all Payables under item (D) of the liabilities of the Balance Sheet of each Italian company, micro company to large company including the loans paid by the Shareholders to the company "shareholders' loans" considering them as a normal element of debt that is not representative of "capital adequacy", which does not represent the reality of the facts, but is only a purely accounting assumption. This news, in itself, is already an "warning indicator" for Companies and Entrepreneurs who, among the value of the total debts, also see the shareholders' loans to the company accounts, since the value of the denominator of the capital adequacy ratio in question will be lower than an adjustment in favour of the "capital adequacy" information purpose.

On one hand, the ratio that measures the capital adequacy of the company is concerned with the actual risk capital that represents the accounting equity adjusted as described above; on the other hand, however, the capital actually used by the shareholders for the company's activities and the related "limiting" consequences for further shareholder loans are omitted, since such new loans by the company could bring the value of the ratio below the alert threshold.

It is unclear still that, while dividends and receivables still owed by shareholders to the company are appropriately adjusted to book equity, this has not been done for the accounting item "shareholders' loans".

This is why the indicator of "capital adequacy" as described as warning indicator for the Business Crisis could be shifted towards the concept of "real capital adequacy" with the indicator of "effective leverage" which, appropriately considering the real debt exposure of the company, allows to "net" the value that would result to the denominator of "shareholders' loans" for the legal justification of "shareholders' loans" to the company are considered as such in bankruptcy proceedings in the same way as risk capital.

This examination of the "capital adequacy" indicator shows that the item "DEBTS for shareholders' loans" is the only accounting item that is not representative of a "crisis indicator" which is intended to measure the real "capital adequacy" of the company as it does not take into account the accounting and equity elements of the company's shareholder structure and therefore for this purpose we have identified that the best indicator of capital adequacy is the "effective leverage" expressed in the following formula: 
 
Effective Leverage = (NET EQUITY - CREDITS vs. COMPANIES - SHAREHOLDERS) / (DEBTS + PAYABLES AND LIABILITIES - COMPANY FINANCING) = value %.

 

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HAPPY EASTER EUROBOND

HAPPY EASTER EUROBOND

In view of the recent difficulties that most European countries are going through due to the well-known COVID-19 Pandemic, the head of government of most affected countries (like Italy, France, Spain) are calling aloud and rightly the solidarity that would subsist on being able to use funds for companies in order to stem/attenuate as much as possible the effects of the economic crisis that are inevitably still unknown to most.

However, from an economic and financial point of view, there are variables that are difficult to assess but must still be considered in any EuroBond issueing, which by the way will inevitably impact savings of private investors.

In addition, the EuroBond issuing in the complete absence of a common and transparent European credit risk control system would inevitably engender the vulnerability of individual countries, especially those with a high amount of debt, since the expected reduction in GDP growth that will be emerge from COVID-19 crisis will thus increase interest on the debt and consequently also the "spread".

Moreover, what will happen to enterprises if will be forced to increase their financial leverage in order to get new debt-financing-liquidity levelheaded through EuroBond issuing ? increasing their credit-risk, stressing their financial sustainability ?

And finally what will be the guarantees and the entities that adequately cover the risks of the new  Eurobond plan ? Each single Member states or the overall EU Solidarity ?

 

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SUSTAINABILITY ANALYSIS: A LOOK THROUGH THE NATURE OF DEBTS AMONG GAAP / IFRS

SUSTAINABILITY ANALYSIS: A LOOK THROUGH THE NATURE OF DEBTS AMONG GAAP / IFRS

In this article we give a general input for the concept of "sustainability", which in the light of COVID-19 it is more than ever of critical importance for the whole ecosystem of businesses, stakeholders, economies and the overall society.

Let's briefly identify why the authorities at international level still tend to broaden the concept of sustainability, but above all, what is meant by "sustainability" of the company. 

The now distant distinction between financial sustainability of debt and environmental sustainability leads to a debate on the possible evolution of some accounting principles that, however still today, do not distinguish in an abstract and transparent way some features of the Financial Statements, such as the aggregate amount owed by trade and payables of a financial nature. 

In fact, it is well known that in the accounting world the item Payables is represented in the balance sheet as liabilities by aggregates of macro classes within source items by destination items that nowadays are still looking more at the form rather than the substance of the nature of accounts.  

Given the pervasive importance of the new regulation of Law at domestic level, a more precise and proper management to tackle the liquidity risk becomes necessary at European and non european level. Particularly in this macroeconomic context it would be much more advisable but also appropriate and necessary to create a standardized accounting information system for a broader concept of sustainability. 

In fact, the new Business Crisis and Insolvency Law  shall be addressed and open to the business ecosystem of businsess and therefore to the actors of the business system who are all more interested in the issue of debt sustainability to guarantee their own credits. 

To this end, the cognitive and informative purposes to be provided to stakeholders' system, is therefore necessary in order to be capable of analyzing the Financial Statements and other data in an unalterable state so that operators can carefully produce appropriate considerations regarding any balance-sheet items of a Company's Financial Statement. This in order to be able to implement in a simple, direct and transparent way for all stakeholders, risk assessments aimed at identifying the right corrective choices for the benefit of companies to clearly communicate their sustainability and survive the dynamism of competitive markets in which they operate.

From a generic point of view, the concept of debt sustainability concerns the forecasting and cash-flow plans of a company, that is applied to companies by the combination of economic variables, equity and financial sustainability. Obviously the analysis of debt sustainability is important because it is precisely the level of debt of a company that continues to finance the business by drawing on medium and long-term financial sources that can make the company itself unsustainable in financial and economic terms.

The point of this headline is precisely related to the importance of greater transparency in the nature of debt because accounting standards do not allow transparent disclosure between trade (commercial) debts and financial debts

These differences are originated into the accounting standards principles that are applied in form of information needed by stakeholders which in substance have important implications from a fiscal point of view, as important as a particular example such as the ATAD (Anti Tax Avoidance Directive) that we intend to address in the context that formulates the real sustainability of companies, and therefore a transparent report and non-modifiable dataset.

Having pointed out this important distinction on the nature of the debts as reported in balance sheets of a company's account, it is plausible to believe that such given public information to domestic and international stackeholders may lack of transparency and credibility towards investors.  

Indeed thanks to the use of XBRL Data Analytics Engine as it allows to anticipate any accounting principles standards information and intelligibility of Financial Statements through a more transparent reporting that will allow to eradicate tangled information in the public accounts and to distribute a considerable information advantage for all stakeholders.

Let's see where is the discrepancy between Accounting principles at the state of the art.  

Liabilities and Equity: distinction based on expected outflow of financial resources or legal-contractual characteristics.  

With regard to the fundamental distinction between Liabilities and Equity, USS GAAP requires certain financial instruments under a legal form of shares to be reclassified as liabilities: shares that are compulsorily redeemable, except where redemption is mandatory only upon termination of the company's operations, and shares that incorporate an unconditional obligation for the issuer to assign other shares with a value based solely or predominantly on predetermined factors. These instruments, even if legally consisting of specific categories of shares, are reclassified as liabilities in consideration of their suitability to produce a reduction in financial resources for the company. 

IFRS adopts instead a classification based on rights and obligations contractually deriving from specific terms of issue or purchase of financial instruments, rather than on the probability of a future reduction on financial resources. The differences illustrated above, on the treatment of individual financial statement items between US GAAP and IFRS/IAS, are significant examples of the differences that can still be identified, despite a gradual process of convergence between the two standards. 

The IASB and the US FASB have been working together for years to promote convergence between IFRS and US GAAP, and, since 2007, the US SEC has allowed foreign companies listed on the financial market to prepare their financial statements according to IFRS without a "reconciliation" with US GAAP (i.e. without presenting their financial statements according to both accounting standards to highlight the differences in terms of economic and financial results), but the subsequent economic and financial crisis reduced the interest of US multinationals in adopting IFRS. At present, the permanence of differences still makes it mutually important for European (and non-US companies in general) to have a full understanding of US GAAP, and for US companies to have a full understanding of IFRS.

While from a European company point of view (and non-US companies in general), the understanding of US GAAP is fundamental in the case of groups with subsidiaries in the USA. Whereas, from a US company point of view, the understanding of IFRS is also important in order to be able to benefit from any economic-financial analysis tool capable of processing instantly, thanks to the underlying artificial intelligence system, the indicators of "economic-financial health" of the company (and therefore of the greater or lesser "credit risk" of commercial counterparties of the company concerned) using data taken from the financial statements prepared in accordance with IFRS and published via XBRL format (eXtensible Business Reporting Language), such as the UNIGIRO search and analysis engine, the first of its kind at European level. 

  

Risk Management Newsletter !

Get more relevant Technical Guides, Research, Videos and Publications from European economics.
Remember that signing up for the newsletter is not the same as signing up for uniGiro services. If you wish to receive information or assistance with unigiro services, please consult the website pages or write to us on the "Contacts" page.

 


UNIGIRO -  MONITORING ENTERPRISE CREDIT RISK

The only  XBRL Data Analytics Engine in Europe for monitoring business crisis and preventing financial and credit risks of companies with up to 100 Dynamic Indicators   


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