FDs' uncertainty: sitting ducks

These days, wherever two or three finance directors are gathered together,
there is an all-pervading sense of gloom.

As the 2009 reporting season gets into full swing, the downbeat note will
only sound louder. The concerns shared by FDs, regulators and auditors, which a
few weeks ago seemed manageable, are now threatening to spin out of control.

If they can be classified under one heading then the word, according to a
senior regulator, would be ‘uncertainty’. FDs are hemmed in on all sides by
bankers, auditors, clients and the general economy.

Split personalities

Let’s take the bankers first (after all, this whole thing started with them).
Bankers appear to be developing split personalities depending on what day of the
week it is. An FD may approach one and find a positive reception for their
ideas, only to be told later that the proposition is now a non-starter.

Many banks are shifting the way they are assessing credit risks, often
deciding to retreat from whole sectors.

The result is that the average FD has no clue whether their banks will be
there for them and for how much.

Banks like to talk of relationships surviving the business cycle; the FD
community now needs that to be more than fine words.

If the banks are unreliable, then so is the customer base. Last autumn, the
chief executive of a major drinks manufacturer could have envisaged, with some
equanimity, the prospect that sales may fall to 2006 levels ­ a year which was
seen as delivering perfectly acceptable results.

A few percentage points off sales would be unpleasant, but they would expect
to survive. But now, for instance, in the automotive sector, some companies are
facing the prospect of revenues collapsing by up to 40%. It is going to take a
lot to survive that.

This, of course, feeds through to the annual reports and especially the words
that need to be penned about future prospects, financing and going concern.

At the end of last year, it appeared that the Financial Reporting Council’s
guidelines on going concern would hold back a torrent of going concern
qualifications. Now the FRC’s template is in danger of being swept aside, with
auditors increasingly nervous about their going concern responsibilities.

This is because if the economic climate leads to large-scale corporate
collapse, the audit profession doesn’t want to be buried beneath a landslide of
legal action. Given the choice between looking to the greater good and not
increasing uncertainty, or accepting the role of sacrificial lamb in the
aftermath of the collapse of 2009, auditors have no doubt what their course of
action will be. The lesson from the collapse of Andersens predicated on a ruined
reputation still haunts auditors and they will act accordingly.

The auditor view on going concern brings us to the accounts themselves. This
is another cause of gathering gloom for corporates and investors alike. A couple
of items stand out and are presently top of the worry list: goodwill and
pensions.

A bad joke

The old joke based on the advert for the Victoria & Albert Museum (nice
café with a great museum attached) that Acme plc company was a pension fund with
a small business attached doesn’t raise much of a laugh these days. A deluge of
data proves that UK plc is in a terrible mess over its pension provision. The
bottom line, printed in big, red letters, is that the pension promises made in
the past are, for a whole host of reasons, far beyond unaffordable and those
promises have to be broken. The same is true of public sector pensions, but
let’s leave that.

Aon Consulting says the accounting deficit of the UK’s 200 largest
privately-sponsored pension schemes currently stands at £29bn, while a
PricewaterhouseCoopers survey out in March says 90% of organisations are
concerned about the risks their pension scheme poses to their business. The
pension scheme is the largest creditor for many UK businesses, and its potential
impact on a business’s robustness cannot be ignored.

Accounting issues add a further layer of complexity. PwC says it sees a
divergence of up to £300bn in the total liabilities of UK pension schemes
calculated on a scheme-funding basis, compared with the lower liabilities
arrived at under accounting rules.

If pension are a headache, so is goodwill for companies which have been on a
debt-fuelled acquisition spree. Companies on both sides of the Atlantic will be
completing impairment testing of goodwill and other long-lived assets and will
have concluded that a significant charge is in order.

You could argue that, as it is a non-cash item and unlikely to impact debt
covenants or liquidity, no one should care. But the billions written off will be
another blow to an already battered balance sheet and profit and loss account ­
and underlines how inept much of the corporate strategy and activity of the past
few years now looks.