Brexit and Company Credit Risk

 

Brexit will present challenges as well as opportunities. For the purposes of credit risk management, in this client note we look at the challenges.

All our credit reports provide a credit rating and credit status review. The following is provided for clients using First Report to screen customers or suppliers in the context of Brexit and the UK economy.

 
Interest Rates and What to Look For

If the UK economy falters in the wake of Brexit, the Bank of England may decide to adjust interest rates. Lower interest rates may be used to stimulate the economy. Making borrowing more affordable can encourage consumers to spend and encourage businesses to borrow to expand. However, encouraging too much indebtedness for consumers or business carries a future risk in terms of debt defaults if interest rates rise.

Brexit concerns have caused sterling to weaken. A weak pound makes sterling denominated exports more attractive for overseas buyers, but a weak pound also increases the cost of supplies and services UK companies source from abroad. This in turn means UK consumers will pay higher prices when they shop. If left unchecked this would lead to inflation. In this situation the Bank of England may decide to increase interest rates.   

You can keep in touch with interest rate data from this link BoE interest rates data.

 
Look for Interest Payable and Long-Term Liabilities on our reports

The level of interest paid is a figure which should attract scrutiny when the figure is disclosed. Note that only large companies (as defined by the Companies Act) are required to disclose a full Profit and Loss Account including details of interest payments. Smaller companies that choose to file only a Balance Sheet may not therefore disclose interest payments, although some smaller companies voluntarily file more figures than the statutory minimum. 

Where no Profit and Loss Account is filed and only a Balance Sheet is presented, the amount of interest being paid to banks and other lenders will not be stated. But the overall levels of liabilities should still be examined. Although liabilities will likely include typical day to day business obligations and creditors, it is possible that there may be some interest-bearing debt too. Long-term liabilities are defined as those due after one year, and long-term debt may indicate long-term borrowing. Where there is little cash (Cash at bank or in hand) on the Balance Sheet, it may be worth considering whether the company always has sufficient liquid cash to fund operations or whether it may rely on borrowings.

When disclosed in the accounts Interest Payable, Cash (at bank and in hand), and Long-Term Liabilities are shown in our Comprehensive Report and our Credit Analysts Report.

 
Sterling Exchange Rate and What to Look For

Brexit concerns have caused sterling to weaken. A weak pound could damage the profitability of firms that have to purchase supplies or services from overseas. If the company has key suppliers which are in the EU, then the chain of supply may represent another difficulty.

Although ultimately foreign currency exchange markets will determine the strength of the pound relative to other currencies, the actions taken by the Bank of England can influence the strength of sterling. 

You can keep in touch with sterling currency exchange rate data from this link BoE sterling spot exchange rates data.

 
What Could Affect Sterling?

Interest Rates: If the UK economy was to experience high levels of price inflation, the BoE could increase interest rates in order to make mortgage and loan borrowing more expensive, and thereby reduce the amount of cash available for other spending, therefore making consumers more price sensitive and price increases less likely, Q.E.D. less inflation.

Quantitative Easing: If the BoE pursues another round of Quantitative Easing (QE) the effect on sterling would depend upon how the financial markets react to the prospect. Broadly speaking the mechanics of QE would be that the BoE creates new reserves for itself and use this money to buy government bonds held by financial institutions (which hold government bonds as part of their asset portfolios). The financial institutions then have a surplus of cash from the sale of the government bonds, and they put this cash to work by lending or investing elsewhere in the economy.

Expansionary Policy: Brexit may result in the Government increasing the amount of money circulating in the economy by using its budgetary policy to increase spending or cut taxes. Key areas of the UK economy may be boosted by the Government spending more on infrastructure and benefitting those sectors. Cutting taxes may also boost the economy through increased spending and investment.

Any increase in the money supply can weaken the currency in the short term. However, if these policies improve economic prospects then the pound may strengthen in the long term.

 
Look for Export Turnover on our reports

Not all companies trade outside the UK, and of these even fewer disclose non-UK turnover in their financial statements. Only large companies (as defined by the Companies Act) are required to disclose turnover, however it is these larger companies that are more likely to have a proportion of their sales generated overseas, or to have a supply chain that makes them sensitive to international currency exchange rates. Large company accounts may (not always) indicate what proportion of turnover is non-UK.

Where non-UK turnover is disclosed, this will be identified in our Credit Analysts Report as Export Turnover in the Notes to the Accounts section of this report.

 
Data Item (When Filed) Basic Report Comprehensive Report Credit Analysts Report
Export Turnover - - Yes
Interest Payable - Yes Yes
Cash (at bank and in hand) - Yes Yes
Long-Term Liabilities Yes Yes Yes
Overdraft - - Yes
Short-Term Loans - - Yes

 

See also: Industry Sectors Brexit Risks

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