Analytical Review 101 – Part IX

Balance Sheet – Current Liabilities

What is a Balance Sheet?
The Balance Sheet shows the position of the company as at the end of the financial year (or as at a specific date). The Balance Sheet contains summary information of all assets and liabilities of the company including its' Intangible Assets, Property, Plant and Equipment, Long Term and Current Assets, Long Term and Current Liabilities and the Shareholders’ Equity. This is noteworthy as it gives us an indicator as to the value or worth of a company.

What do Current Liabilities represent?
These are liabilities or obligations of the business that must be paid in cash within a period of one year. It usually consists of trade payables, other payables, loans and borrowings and taxation, that are due within a period of 12 months from the balance sheet date.

1. Trade Payables
Trade Payables consists of amounts due to creditors and suppliers. These amounts arise because most long term suppliers would give credit terms to the company. The average credit period given by the supplier would depend on, inter-alia, the relationship between the company and its’ suppliers and the type of goods sold or services rendered by its’ suppliers.

The longer the credit period given by the suppliers to the company, the larger the trade payables amounts recorded in the Balance Sheet. Why would suppliers grant credit periods to the company? Wouldn’t it be better for the suppliers impose Cash on Delivery (COD) terms on all purchases by the company?

Purchases by a company are usually on credit terms because most companies expect to be given credit terms as a gesture of trust and goodwill. Companies usually try to negotiate and obtain favorable credit terms from its’ long term suppliers so as to conserve its’ cash flows.

A sudden increase in trade payables of a company as compared to previous years, is not always favorable. True, the company is conserving its’ cash flows by paying its’ trade creditors later. However, this may be an indication that the company is facing cash flow problems and is UNABLE to pay its’ creditors on time. Another possibility is that the company’s operating cash flows may be used to pay off other more critical obligations such as repayment of loans to banks.

2. Other Payables
These usually consists of:
(a) Amounts due to related companies (trade and non-trade); and
(b) Other payables;
(c) Accrued Expenses.

By and large, this figure is stable and does not change significantly over the long run. It is usually not significant in the evaluation of the company’s value.

However, in Nestlé’s case, it is significant to note that the company owes its’ related companies approximately RM129MIL. Approximately 33.50% of these debts are trade related whereas the balances of 66.50% are non trade. A review of the cash balances of Nestlé’ reveals a balance of only RM31.6MIL. If these related companies were to require immediate repayment, the company would have insufficient cash to repay these obligations.

This further indicates that Nestlé may be pursuing an overly aggressive dividend payout policy and financing this partly through inter-company payables. Approximately 39% of these inter-company payables (i.e. RM50.15MIL) is a short-term loan denominated, in Japanese Yen and interest bearing at 3.72% per annum. The balances of RM78.85MIL are unsecured, repayable on demand and interest-free.

The above facts indicates Nestlé dividend policy may not be sustainable in the long run. The company must conserve its’ cash flows, if it is to repay its' mounting of debts and obligations. However, it is pleasing to note that the inter-company payables have been halved in 2007 as compared to 2006.

3. Loans and borrowings
For a company with such strong operating cash flows, it is disconcerting to note that the company’s short term loans and borrowings have ballooned almost fourfold in 2007. The company’s short term loans and borrowings is currently RM303MIL now, compared to only RM67MIL in 2006. This is a substantial amount and the company is unlikely to be able to repay this withing a period of one year, since it’s’ cash balances are only RM32MIL. It must refinance these loans. Further scrutiny is required on the loans and borrowings amounts.

4. Taxation
These usually represents amount of tax payable to the Malaysian Inland Revenue. It is generally not significant in our evaluation of the value of a company as it is largely out of the company's control.


Conclusion:
We have appraised and analyzed the major components of the current liabilities of Nestlé. The important components have been highlighted for further review, namely the inter-company payables and loans and borrowings. These will be looked in detail, in my future posts.