Yet another big company listed on the Stock Exchange has reported a loss. Actually, there has been only a modest fall in trading profits, but this sets off a chain reaction. The premises that the company trades from are only worth the expected future revenues from the trade, and a fall in profitability implies a fall in expected future revenues and therefore a fall in the value of the premises. Often this fall in the value of the premises swamps everything else, and it looks as if the company has made a huge loss. This is what hits the headlines.
If the company originally bought or built its own premises, then often the value of the premises at historic cost is well below the valuation based upon expected future revenues, and no problem need arise. However the company in the meantime is likely to have revalued its premises upwards to their market value in order to be able to borrow money on the strength of the estimated current value of the premises. This latter estimate is much more volatile, and the company that does it is likely to find that “it never rains but it pours”.
Another thing the company might do is to acquire other businesses. Often acquisitions are at the height of a boom in the market, and often when the bust comes, it will look as if far too much was paid for the acquisition. This then has to be devalued on the balance sheet, making the apparent loss much bigger.
As a rule, if you read about a company making a big loss, it isn’t always as bad as it seems. A former employer of mine, whom we will call Hacksaw, once reported a loss which was bigger than its annual turnover, which made me comment that had I produced accounts like that, I would have got the sack. The source of loss was that it had acquired many accountancy firms at an overvalue, and the bubble was bound to burst sometime.
David Porthouse & Co is a firm of accountants based in Carlisle in North West England. We have a keen interest in new technology with the aim of speeding up accounts production and making accountancy more affordable for our clients.