Does your balance sheet show a true and fair view of your company's financial position? In this revealing episode, Darren Vardy exposes how balance sheets can mask insolvency through unrealistic asset valuations. Learn about a security business that appeared to have $400,000 in positive net assets but was actually insolvent by $1.7 million due to an inflated goodwill figure. Discover why directors must understand Section 286 of the Corporations Act, how to assess the realizability of sundry debtors, and when goodwill valuations need to be updated. Darren shares practical strategies for ensuring your balance sheet reflects reality, not optimism.

KEY TOPICS COVERED:

• Section 286 of the Corporations Act - director's obligation for true and fair records • Why balance sheets don't always tell the full story • Assessing the realizability of sundry debtors and aged receivables • Understanding goodwill valuations and when they need updating • How trading losses impact goodwill values over time • The danger of relying on positive net assets without deeper analysis • Case study: $2 million goodwill masking $1.7 million deficiency • Why directors should get business valuations every two years • The difference between book value and realizable value • How to identify when assets are artificially inflating your position

KEY TAKEAWAYS:

✓ Section 286 requires directors to maintain records showing a true and fair financial view ✓ Positive net assets on paper don't always mean the company is solvent ✓ Aged debtors beyond 90-120 days should be provisioned as doubtful or written off ✓ Goodwill values diminish when businesses trade at losses for extended periods ✓ A $2 million goodwill figure masked a $1.7 million actual deficiency in one case ✓ Directors should obtain business valuations every 2 years to assess goodwill accurately ✓ Trading losses for 3-4 years indicate goodwill has likely diminished to zero ✓ Book value of assets often differs significantly from realizable value ✓ Looking only at balance sheets without profit/loss analysis can be dangerously misleading ✓ The cost of business valuations is small compared to the risk of trading while insolvent

Balance sheets and goodwill.

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Understanding the true financial position.

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Welcome to IO Insolvency Options

with Darren Vadi, the managing

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Director of Insolvency Options

and a registered liquidator.

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With over 30 years of experience

helping businesses and individuals

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navigate financial challenges.

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In today's episode, Darren Reveals Why

balance sheets don't always tell the full

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story and how A $2 million Goodwill figure

can mask a company's true insolvency.

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He explains the critical importance

of Section 2 86 of the Corporations

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Act, which requires directors to

maintain records showing a true and

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fair view of their financial position.

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You'll learn about age debtors,

goodwill, valuations, and why directors

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must look beyond positive net assets.

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To understand their real exposure.

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I'm your co-host, Anthony Pearl.

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Let's dive into unlocking

more about insolvency options.

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Well, Darren, welcome I, here's a big

question about balance sheets for people.

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Is it actually telling the full story?

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What are we missing when we

just look at the figures?

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Darren Vardy: I think what we need to

do is also go back, Anthony, and not

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only look at the balance sheet, but

look at the director's obligation,

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which come under section 2 86 of the

Corporations Act, which says that a

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director must maintain records insofar

as that they show a true and fair view

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of the financial position of the company.

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So then when we turn to

look at balance sheets.

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We need to look at what they're

made up of and really have a good,

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hard think as to whether or not

the assets are truly realizable.

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There's a lot of different factors that

go into the assets of a balance sheet.

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They can be made up of things

such as sundry, debtors, goodwill.

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And the like.

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And you know, there's a couple of key

areas which directors really need to focus

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on when looking at those assets to make

sure that they do actually accurately

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reflect the true position of the company.

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For instance, when we look at, say,

sundry debtors, are those debtors

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whilst they might carry the book value.

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Of what is owing to the company.

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The question is, well, are those

debtors actually realizable?

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And that's where you need to pull

the age report and say, well, okay,

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how much old debt do I have here?

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Are they all within a reasonable

tolerance such as 30 to 60 days?

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Whereas when you have debtors

that are out ninety, a hundred

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and twenty, a hundred fifty days.

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Concerns need to be addressed as

to the recoverability of those and

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whether or not a provision should be

put through as to whether or not those

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debts are doubtful or in fact, if

they're bad debts, and they should be

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written off entirely as unrecoverable.

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So that's one area within the assets of a

balance sheet that needs to be looked at.

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Another key area that we've

seen in the past is the goodwill

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figure, and particularly where

businesses have been purchased.

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And quite often you'll see we had a

situation with a security business where.

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The business was purchased for $2 million.

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So in the balance sheet there

was a $2 million asset called

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Goodwill, as you would expect.

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Now, because the directors had actually

purchased the business with their own

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funds, at the beginning of that, there

was a corresponding liability called

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director's loan or shareholders' loan.

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Now, over the years, this

business operated for about.

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Seven to eight years.

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And over the years, instead of

the directors being paid a wage,

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they were just out of the profit.

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In the early days, they were repaying

their $2 million loan, which is fine, and

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paying tax on the profits as they went.

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But the issue then turned to

where they started to become.

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Unprofitable or loss making.

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And what we found is that throughout

the first couple years, the business was

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going okay and slightly deteriorating.

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But for the remaining four years leading

up to my appointment as liquidator, the

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business deteriorated significantly.

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And whilst that was shown in

the profit and losses, losses.

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The directors were looking at

the balance sheet saying, well,

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hey, we've still positive.

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We've still got positive net equity.

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Now on paper, they still had positive

net equity, but that was being, for

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want of a better term, artificially

inflated by this actual goodwill figure.

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Now, any business that operates for a

number of years at loss making position,

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it's hard to argue that there is any

goodwill from the trading of the business.

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So certainly over a period of time.

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During those loss making period,

they probably should have adjusted

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the actual goodwill figure down and

sought a valuation to determine if

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goodwill was continuing to exist.

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And so at the date of my appointment as

liquidator, whilst they had a positive net

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asset position, they traded, as I said,

for two to three years, making losses.

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Therefore that Goodwill

was Unre unrealizable.

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So really the business was only worth the

value of its tangible assets in the end,

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as opposed to the business being valued

on a going concern basis because of the

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losses made over the last three years,

that going concern value had diminished

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down to down to a zero sum gain.

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So in that instance, the

balance sheet did not reflect.

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The true and accurate position of

the company unfortunately, was that

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balance sheet that the directors were

relying on when looking at the numbers,

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not necessarily the profit and loss.

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They were looking at it from a

balance sheet point of view saying,

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well, we're still okay because our

net asset position is positive,

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when in fact in reality it wasn't.

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Anthony Perl: Yeah, there's

a lot of questions here.

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I mean, firstly starting out

and how do you even measure

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goodwill in the first place?

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I mean, was the initial

figure even correct?

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Darren Vardy: The business was

purchased, a valuation was obtained

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for the purchase of the business.

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Was that valuation correct?

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Unable to comment, however,

that was the amount that the

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business was actually paid for.

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So it's not unusual or uncommon for that

purchase price off the back of a valuation

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to go into the books as as Goodwill.

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We always advise business

owners that if they're gonna.

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Purchase a business, they need

to do their due diligence and

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importantly get a valuation done.

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So that's your first step, is to determine

what is the value of the business

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and if there is any going concern

value, which gives rise to goodwill.

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Absolutely.

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So I don't believe that they urged in

their process of getting a valuation

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and properly recording the goodwill.

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It's what was the business doing?

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Thereafter, how is it trading thereafter,

which can positively or negatively

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impact that goodwill component?

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Anthony Perl: Yeah, I think

that's an important thing for

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people to understand, isn't it?

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That if the goodwill is valued at a

certain amount going into the business,

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what you do with it, the business

can make an impact on that goodwill.

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And that's where you have to adjust

those figures is what you're saying.

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Darren Vardy: Correct.

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And that can be for the

good and for the bad.

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You know, I know that

with certain investments.

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There are valuations done periodically.

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Now, you may not get a valuation

done annually, but certainly

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some auditing processes require

a valuation done every two years.

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Now, if you've purchased a business

and you have a sizable goodwill

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component, maybe that's the answer.

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Maybe the answer is that every second

year you, you have a look at your

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business and get it valued to determine.

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Whether the goodwill component has

actually increased or decreased.

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And then if you find that the Goodwill

component has decreased, it's a flag

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as to, well, why is it decreased?

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What do we need to look at?

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And it might be a lead into looking at

some other issues within the business

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that can be addressed at an earlier stage

to ensure that the business doesn't.

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Continue to trade in a lost

situation, ultimately ending

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up in an insult position.

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Anthony Perl: Is it a difficult

thing to measure goodwill?

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Darren Vardy: Goodwill is easy

to measure so long as it, the

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valuation process is followed.

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And we're not talking a large cost to

get a valuation of a business neither.

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It's just knowing that that's what you

should do as part of your process to

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keep an eye on the value in, because

intrinsically, that is the value

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in your business, is your goodwill.

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Anthony Perl: Absolutely.

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And so talk me through what happened

here, because they find that the goodwill

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that was originally part of the purchase

price had now significantly diminished.

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Darren Vardy: So in this particular

situation, we found that the business

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was recording with that Goodwill

figure, a positive net asset position

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of about three to $400,000, when

in fact the business had traded at

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significant losses in the previous.

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Three to four years.

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One of the reasons why the business

had traded a loss is that it then

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sought to acquire another business,

which was geographically quite a

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long way away, and they never really.

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Properly took control of that

business and were able to run

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both businesses in unison.

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So the losses that were sustained,

or the trading losses that were

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sustained over that period of

time effectively represented the

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deficiency in assets to liabilities.

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Leading aside that $2 million

goodwill figure resulting in

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a deficiency of around 1.6,

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$1.7

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million.

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And the majority of that money was debt

owing to the a TO for unpaid PAYG and GST.

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Anthony Perl: And that's where it starts

causing even further problems, doesn't it?

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Because when you start owing the tax

department, then you've got bigger issues,

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Darren Vardy: correct?

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Correct.

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And during that last three to four years,

there were other signs of insolvency.

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You know, the company had had demands

from their creditors for payment.

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They had entered into payment arrangements

with the tax office, which they had

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breached on a number of occasions,

and those signs, I think may have been

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ignored because they continued to look

at their balance sheet, which show the

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net asset position, which was incorrect.

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Anthony Perl: So what happens when you

come into the picture and you just start

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discovering some of these things, which

I imagine happens fairly quickly that

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you discover these sorts of issues.

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What's the first steps that you take?

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Darren Vardy: Sure.

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Well, before we get appointed, we have

a look at what the financial position

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is and ask the questions, and one of

the first questions was, where did this

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$2 million goodwill figure come from?

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Because given the fact that there

had been trading losses of $1.7

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million in the couple

of years leading up to.

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Being called in from a theoretical

point of view, it didn't make sense

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for there to be goodwill at all.

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So then it was disclosed that there was

a business purchase, which is reasonable,

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and the purchase price was $2 million.

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So then the conversation quickly

turned around to, well, hey, you may

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have paid $2 million for a business,

but given its trading history,

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recent trading history, that $2

million is diminished down to zero.

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So a hard conversation.

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Had we had with the directors so

they could actually understand

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that what they paid for eight

years ago was worth nothing today.

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So then we looked at what options

were available, you know, was there

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an option to turn around the business?

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Was there an option to do a small business

restructure or a voluntary administration

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and a deed of company arrangement to

trade out of the financial position?

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And upon looking at this

particular business.

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We had an elderly director shareholder

whose last eight years had spent

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trying to run this business,

unfortunately, unsuccessfully and.

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When asking, well, you know,

what's the future look like?

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What do you want to do?

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They really did not have the energy

or the time to try and put back

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in all the money for that matter.

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'cause every turnaround

requires working capital.

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And unfortunately, they'd

exhausted all theirs.

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So they were in a position where they

really didn't have the wherewithal.

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Either visibly or mentally, so to

speak, to actually go through the

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journey of turning this business around.

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So the only real alternative

was to liquidate the company.

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And once we're appointed to liquidate

the company, our role is, is then to

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secure the assets and realize the assets

now being a security business, the

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assets with this particular business,

were money owing from its customers.

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So trade debtors, plant equipment.

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And motor vehicles, 'cause they

did run security monitoring and

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as well as site inspections.

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So they did have a fleet of vehicles

that we then had to sell and looked

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to recover all the trade DES for the

benefit of the company's creditors.

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Anthony Perl: So how did that process

play out over the period of time then?

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Darren Vardy: Unfortunately, the

trade debtor recovery was difficult

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because we had large volume.

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Of low dollar value debtors and you

also had a number of customers whose

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service was terminated without notice.

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So that was a difficult process to recover

or or realize to train debtors and.

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As well, we found that a number of those

debtors were far outside terms, so we,

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we were forced to a position where I

think we only recovered probably 20, 25%

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of what the actual book value of those

debtors were through a combination of

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very old un realizable debtors, as well

as people who simply did not want to pay

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because their service was terminated.

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And it was uncommercial to try and

pursue those particular customers

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in respect to the motor vehicles.

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They were all sold and market value

was achieved via an auction realization

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process, and funds came in in the

ordinary course in that regard.

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But it's probably fair to say that

there was little, if any, return.

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Two unsecured creditors after

the cost of realization and the

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payment of the priority employee

entitlements were dealt with.

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Anthony Perl: So the end of all

of the process, where are the

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owners of that company and where

does it leave them for future?

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Darren Vardy: Sure.

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So the process resulted in.

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The directors and shareholders

effectively being out of pocket $2

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million because that's what they had

invested in the purchase of the business

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in the first instance, for which they

had equity and property at the time.

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They used that equity in their

property to purchase the business.

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So really from an overall

perspective, they have.

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Lost wealth as a result of

the business investment.

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Anthony Perl: And that's all we

have time for in this episode.

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But next time on IO insolvency options,

we'll explore how good businesses go bad.

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For boring reasons.

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Darren will share a shocking case study of

a holding company that collapsed due to.

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Single lease guarantee,

bringing down three profitable

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subsidiaries in the process.

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It's a cautionary tale about

structural mistakes that every

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business owner needs to hear.

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For details on how to get in touch

with Darren and his team on insolvency

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challenges, please consult the show notes.

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team at podcast done for you.com

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Until next time, remember, there's always

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