Due diligence

Customer Screening: A Guide to Understanding Company Accounts

by Nicolae Buldumac
Customer Screening: A Guide to Understanding Company Accounts

When it comes to protecting your business, ensuring that you have confidence in your transactions is essential. Whether you're taking on a new high-value client, entering into a long-term contract or trying to qualify potential leads, getting hold of another company's financial history can be a huge help in determining if you are facing any possible risks.

This is where company accounts can come in extremely useful. All businesses are legally required to submit financial statements every year, and the information contained in these can provide excellent insight into the business' current stability as well as how secure their future looks. Although looking into accounts can seem like a daunting process, with some basic know-how you will soon be able to use them to your company's advantage.

What are Company Accounts?

All public and private limited companies in the UK are required by law to submit their annual accounts to Companies House. Exactly what information a company needs to provide is dependant on the size of the business, which will be classified as either small, medium or large. Several criteria is taken into account when determining which of the three options each business falls under, including annual turnover, balance sheet total and number of employees.

Small and medium companies can file abbreviated accounts, while those that are classed as large must file full accounts, as must all public companies and those that are in the  Generally speaking though, there are three main components that make up the company accounts and that will give a good overview of their financials. These are:

Balance Sheet

The balance sheet is the most important part of the accounts, as it shows a company's worth. It contains information about what is owed by the company as well as what it owes, and is therefore a great snap shot which illustrates just how well the business is doing at the current time. The balance sheet must be signed by a director on behalf of the board, and it must show the printed name of this person.

The balance sheet is usually made up of three sections:

  • Assets - Can be listed as liquid assets (e.g. cash), or non-liquid assets (e.g. land or property).

  • Liabilities - These are simply funds that the company owes, and can be either current - meaning they must be paid within twelve months (e.g. wages and utilities), or long-term (e.g. long-term loans and pension payments).

  • Net Assets - The amount that is left after taking the liabilities from the assets.

These can be seen in the simple example below from The Open University:

Profit and Loss Account

This is the summary of the income the company has achieved along with the costs they accrued in the process. Unlike the balance sheet, it is less helpful for determining the current financial health of a business as it contains the figures for the entire previous twelve months. In order for a profit to be made, the total revenue must be higher than the total expenditure.

Director's Report

The Directors' Report contains information about the company's current state as well as how it has complied with several regulations. It is put together by the board of directors but must be independently audited. The report must include information such as:

  • The names of the company directors for that year

  • The printed name of the director or secretary who signed it

  • A summary of the company's trading activities

  • The company's future prospects

  • Any important changes in the value of the company's fixed assets

  • The recommended dividend for the year.

     

Why Check Company Accounts?

Looking into a company's account can give you a real insight into its financial health. Using the information that they contain in order to perform due diligence on new and existing customers can help protect your business in a number of ways, including:

Can they afford to pay?

Receiving a high-value order from a new client is obviously very exciting - as long as they can actually afford to pay. By analysing the company's profits and losses over the last twelve months you'll be able to gauge whether or not the company is making a lot of money, and if the business is growing or not.

This can also prove extremely useful when qualifying potential leads. By delving deeper into a company's accounts you can get a good sense of if they can afford your product or service - which will save time and money in the long run as you can then decide to focus instead on those companies that are more likely to actually make a purchase.

Will they pay on time?

Late payments can be extremely disruptive to small businesses - as is evidenced in the infographic from Sage Small Business Panel - so it's a good idea to look at a customer's accounts in order to see if they have a history of late payments. By analysing their balance sheet you will be able to see the amounts that the company currently owes its suppliers for products it has already received. If the report does show that the business has been taking a while to make payments, you may need to plan your own cashflow accordingly.

What's more, if the total amount of debt is higher than their sales it could signify bigger problems, and may be a sign that you should avoid the company altogether.

Are they in a lot of debt?

When looking at the company's balance sheet, be sure to pay close attention to the amount of money that they owe. If this amount is increasing it could signify that they are struggling. This is particularly important when it comes to any long-term contracts that you may be considering entering into; you need to know that the company has a stable future so that they are able to fulfil their end of the deal.
 

Company Accounts Myths

  • They are easily manipulated - While it's true that some unscrupulous companies do manage to alter the data in their accounts to their advantage, this is actually very rare. The regulations surrounding the reports, as well as the fact that they must be independently audited by a trained professional, means that the data you see is accurate in the large majority of cases.

  • They're stuck in time - Although company accounts do only offer a 'snap shot' of a certain period of time in a business' life, comparing the reports to those of previous years means that you can build up a more thorough sense of its history, which in turn makes it easier to determine whether the company is growing and what its future prospects look like.
     

Accounting Glossary

When using company accounts to perform background checks on other businesses, you may be concerned about the terms and wording contained in the reports. However, a little reading up on the required language will mean that you don't need to be a trained accountant in order to analyse the information. Some of the most useful terms include:

Accounts payable – The amount that the company currently needs to pay to its suppliers, also known as trade creditors, for the goods or services it has received.

Accounts receivable – The amount that the company is currently owed by customers, also known as trade debtors.

Accounting period – The period of time for which the financial reports are prepared (e.g. quarterly, annually)

Assets – Something that the company owns, for example a building or a trademark.

Capital – The amount of funding given by the owners of shareholders in order for the business to continue.

Dividend – The amount paid to a shareholder, in proportion to the number of shares that they hold.

Gross – The total amount of sales before any deductions.

Liabilities – The debts that a business currently owes.

Profit – The company's total income minus their expenses.

Share capital – The total amount of finance that has been given to a company by its shareholders.

Turnover – The revenue that has accrued from the business' operations.
 

More Important Background Checks

If you've made the decision to screen a company before entering into business with them, chances are you'll want to be as thorough as possible. Alongside their accounts, there are several other sources of information that can be equally useful when it comes to gaining a clear picture about a company's trustworthiness and financial health, such as:

  • Company profile - The trading addresses of the business along with details about its structure and directors. Information about any previous trading names can also prove to be very useful when it comes to looking for any potential risks.

  • Credit score - One of the most reliable ways to determine a company's trustworthiness as well as their ability to pay is to find out their credit score. Credit bureaus will use a variety of different factors in order to calculate the score, such as the company's payment history, revenue, and their overall use of credit.

  • Unfavourable public records - One of the biggest red flags when screening a company is learning that they have been granted negative records, such as liens, judgments, and bankruptcies. Obviously any businesses that have several such notes on their record should be approached with caution, particularly if they are recent.

  • Shareholder information - In order to get a thorough picture of a business, you'll want to know exactly who is involved or associated with it, so finding out who owns shares is an important factor. You should therefore ensure that the risk assessment service you use when researching businesses provides this information.
     

Global Database – a one-stop Solution...

Thankfully, when it comes to performing detailed due diligence checks on customers there is a way to make the whole process quick, easy and hassle-free.

With Global Database's Business Credit Reports you can gain immediate access to ten years worth of company accounts, as well as credit scores, company summaries, shareholder information and details of any liens, judgments, or bankruptcies.

Our unique methodology provides users with an accurate and realistic credit score, as well as suggested credit limits, so that you are able to qualify prospects and suppliers and make an informed decision before going into business with new clients.

Ready to ensure your business is protected from bad debt and risky business deals? Take a look at our award-winning credit risk platform here.

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