Solvency and Liquidity and Corporate Governance Flashcards
Definition of solvency test
• Section 4 of the Companies Act
• means that assets, fairly valued, must exceed or in the very least equal the fair value of liabilities - resulting in a net assest position
• if at any point the liabilities are greater than fair value of its assets, the test is not met.
Liquidity
Refers to the company’s ability to pay off its short-term debt obligations. Calculation of a liquidity ratio is done by comparing a company’s most liquid assets, those that can be easily converted to cash with its short term obligations
When will company meet its liquidity test
If it appears that the company will be able to meet its obligations towards creditors as they become due for a period of 12 months
When and why must the solvency and liquidity test be applied and passed?
Prior to a company taking certain transactions.
Part of fulfilling purpose of Section 7 of Companies Act - ensuring enterprise efficiency and promoting efficient and responsible management of companies
importance of the test
Designed to help directors with wise financial-related decision-making
scope of application of solvency and financial test
- when company wishes to provide financial assistance for subscription of its securities
- company intends to grant loans/financial assistance to directors and others contemplated in s45
- company wishes to acquire its own shares
King IV proposals on board committees
proposes that board committees be established to assist the directors by giving detailed attention to important areas.
The important committees
- Remuneration
- Nomination
- Risk Management
- Audit committee
Function of remuneration committee
make recommendations to the board on specific remuneration packages for each of the directors
Nomination Committee Function
- to assist the board in the formal and transparent procedures leading to board appointments as well as appointment of company secretary
Risk management Committee
- assists the board in reviewing the risk management process and any significant risks facing the company
Stakeholders and shareholders
- Shareholders are stakeholders in the company but stakeholders encompass mote than simply shareholders. Potential shareholders, employees, trade unions, customers and suppliers are also stakeholders
Should non-financial information be included in a company’s annual financial statements
• King IV provides that non-financial information should be included in a company’s annual financial statements and that broader stakeholder interests should be addressed
• Annual financial statements report on social and environmental issues
• King IV recommends company not only report on profit but also on planet and people
Impact solvency and liquidity test has on preparation and maintenance of company’s financial statements and records
any information to be considered when considering solvency and liquidity test must be based on accounting records that satisfy requirements of section 28 and on financial statements that satisfy requirements of section 29
Section 28
Accurate and complete records must be kept enabling a company to satisfy its obligations with regard to the preparation of its financial statements
Section 29
Emphasizes need for the fair presentation of a company’s affairs and the need to comply with IFRS
Investors and information they may require from company
● need to know about financial situation of the company to assess the certainty and amount of future dividends
● assess risk of losing their capital
● probabilities of growth in their investment in the company
Employees and trade unions
● require information to assess the risk of liquidation of the company and to determine the ability of a company to generate cash flow to pay salaries, retirement benefits
Lenders
● require information to assess the probabilities of being repaid capital that they have lent to the company and assess risk of making further advances to the company
Suppliers and traders
● require information to determine ability of the company to generate cash flow to pay its suppliers and to determine terms of business between the company and its suppliers
Customers
● need to assess whether there is a risk to future supplies from the company
Government/SARS
● require information to assess the tax liabilities of the company and to regulate its activities
General public
● needs to assess the environmental issues connected with the company and the company’s contribution to the national economy
Investment analysts
● need to assess the financial performance of the company to advise actual and potential investors
Does King IV Code apply to all public companies
● Not law
● listed companies required to apply its provisions because JSE listing requirements require such companies to do so
● companies not listed can voluntarily apply the code or such parts they choose are beneficial, relevant and cost effective
Triple-bottom-line reporting approach
provides that a company should include in its financial statements information regarding the economic, social and environmental aspects of a company’s activities.
