According to UK Finance, lending to SMEs in the first three quarters of 2020 was more than double that during the whole of 2019. 2023 sees UK businesses facing a variety of new challenges.
UK businesses are facing a tough challenges in 2023; increased costs, inflation, interest rates rises, supply chain issues and an energy crisis are reducing profits whilst draining cash reserves. These issues stopped the recovery to the UK economy that had been predicted to take place in 2022. A recent Red Flag Alert report found that after Q4 2022 610,405 companies are facing significant financial distress.
Many companies ability to borrow money to help them stay afloat has been significantly affected by the COVID years of 2020 and 2021. Their ability to do business in this time was significantly reduced and many were forced to take out government loans, which are now being called in. This has led to many having very low net assets, which makes institutions less likely to offer loans.
But what is a company’s net asset value and how does it affect a company? In this guide, we explain everything you need to know about net assets and outline how you can use them to calculate the value of your business
What are net assets?
The money that a company holds in the bank or the revenues that it generates are critical in determining its value.
However, they aren’t the only important factors. Assets such as property, machinery or technology also add to this figure, as do liabilities such as debts and assets operating liabilities.
When a company’s assets are valued against its debts the figure is known as ‘net asset value’.
This value is used for important financial tests against the company. Examples include getting business credit or satisfying partners and creditors that the firm is financially sound.
Net assets can be calculated using a business's balance sheet, which will generally show its assets, liabilities, and the company's net worth attributable to its shareholders.
A business’s valuation is partially determined by its net asset value, and accounting convention dictates that a company's worth is equal to its total assets minus the sum of its total liabilities. This typically means that a high net asset value will equate to a higher business valuation.
It's important to note that company assets can come in two main forms: fixed and intangible. Fixed assets include things like plant and machinery, buildings, tools, vehicles and other items that are generally easy to value.
Intangible assets are often much harder to quantify and include intellectual property such as patents and trademarks, along with the knowledge of key business personnel and any goodwill that has built up over time. This could include cash accounts receivable where which is money held up in unpaid invoices by clients.
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Case Study: London Capital Finance
London Capital Finance (LCF) collapsed in 2019 owing around £240m to retail investors.
The company was found to have net assets of £62.3m against debts of £72.5m—giving it a negative net asset value of nearly £10m.
As a result, the company was highly unlikely to ever pay off its debts and it was found to have been technically insolvent for nearly two years.
Companies in this position will often struggle to get credit and have poor relationships with customers, suppliers and shareholders due to the unstable position of the company—however, LCF somehow managed to mask this.
How to calculate net assets
A company's net asset value can usually be expressed as follows:
Total Assets - Total Liabilities = Net Assets
The calculation can also be broken down further to reflect different types of assets and liabilities, for instance and will give you insight into stockholder's equity :
((Total Current Assets + Total Fixed Assets) - (Total Current Liabilities + Long Term Liabilities)) = Net Assets.
What counts as an asset?
Business assets are sources of value that the business owns, generates, or financially benefits from.
Assets can generally be categorised based on whether they are fixed or current. A firm's fixed asset value reflects the current value of its major purchases and key property such as vehicles, computers, and properties. Other items falling into this category might include raw materials and intangible assets, such as consumer popularity and intellectual property.
Current assets include any cash available to the firm, along with money owed by debtors and any stock that's ready to be sold.
What counts as a liability?
A liability is anything that your business owes. This could be money owed to a bank, your suppliers, your employees, or even the courts and any entities that might bring legal proceedings against you.
Business liabilities include tax bills, loans and credit cards, and any commercial credit from suppliers. They can generally be split into current and long-term liabilities.
Current liabilities are usually payable within the space of a year or less. They can help you to calculate the liquidity of your business, and examples include costs such as accounts payable, bank loans, and employee salaries.
Long-term liabilities are debts that do not need to be repaid in the short term. Examples include loans due more than 12 months in the future, deferred tax liabilities, and pension scheme obligations.
You may also come across contingent liabilities, which are those that your business might have to pay depending on the outcome of an event—for example, a court case.
Useful net asset calculations
In addition to the simplified net asset calculation, there are also a number of other formulas that can help you to understand more about a company's financial health.
Let’s take a look at some of them.
Net operating assets
Net Operating Assets formula (NOAs) reflect a company's operational value. This formula can give an indication of which assets are cash generative, and therefore make the business money. Assets that typically fall into this category include: patents, inventory, buildings, and equipment.
Total Assets - Total Liabilities - Financial Assets + Financial Liabilities = Net Operating Assets
Net fixed assets
Net Fixed Assets reflect the depreciation of assets over time. This calculation can help companies to keep tabs on whether assets need to be replaced, and how their reduction in value can affect the business's overall value.
Gross Fixed Assets - Accumulated Depreciation = Net Fixed Assets
Net tangible assets
As explained previously, businesses usually have both tangible assets (such as inventory and property) along with intangible assets (such as patents and brand value). Calculating the value of net tangible assets can help you to focus on the physical value of a company in a more easily quantifiable way. It's also worth noting that tangible assets can usually be liquidated more easily to provide the business with additional cash.
Total Assets - Intangible Assets - Total Liabilities = Net Tangible Assets
Understanding net asset value
Companies that are struggling with their finances are more likely to have low or negative net assets. The figure can therefore be a good indicator of whether an organisation poses a credit risk, and can help to inform prospecting, sales, and financial decisions.
Red Flag Alert reports on the financial health of every business in the UK, making it easy to gauge whether a creditor or potential client has sufficient liquidity to pay your bills. Our credit risk management tool simplifies the process of vetting the finances of other companies, allowing you to focus on business-critical tasks and enables you to understand if your debtors business actually generates revenue.
The Red Flag Alert database is updated over 100,000 times every day, and users can also:
- Accurately predict insolvency risk
- Access our system's industry-leading financial health ratings for over 6.5 million businesses
- Monitor the financial health of your clients
- Determine the level of risk posed by clients, and set credit terms accordingly
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Request a free trial today to find out how Red Flag Alert’s company credit checking solution can help your business.