All company directors need to have a basic understanding of financial matters
As a company director, regardless of whether you are an executive or non-executive director, you have a legal obligation to exercise reasonable care, skill and diligence in the execution of your board duties. This is particularly true when it comes to the financial affairs of the business.
The two main financial questions a director needs to understand and be able to answer are:
- Is the business solvent or is it trading whilst insolvent?
- Are the published annual accounts a true and accurate representation of the financial state of the business?
If you are a company director and you do not have a financial background then you need to ensure that you have the basic financial skills and knowledge to address these important issues. The law governing your director’s duties, principally the 2006Companies Act is very clear on the requirement for all directors to have a basic understanding of financial matters. This Institute of Chartered Accountants in England and Wales made the following references to director’s duties in the statement issued in October 2008:
‘Executive’ and ‘non-executive’ directors have the same duties in law. An ‘executive director’ is merely a director who has specific delegated responsibilities within the company, as an executive. Directors are not required to give continuous attention to company affairs unless their executive position so requires. However, all directors, including non-executive directors, should familiarise themselves with the company’s affairs, including its financial position, and should attend meetings of the board, and of any committee of the board of which they are members, whenever they are reasonably able to do so
In performing their duties, directors must exercise reasonable care, skill and diligence. This means the care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company (sometimes called the objective test) and the general knowledge, skill and experience that the director has (sometimes called the subjective test) (Companies Act 2006, section 174). Under the objective test, in general more would be expected of a director with an executive function (particularly a specific function such as finance director), whereas under the subjective test more would also be expected of a director having specifically relevant knowledge, skills and experience (such as a member of a recognised Accountancy body in respect of financial matters).
In relation to financial and accounting matters, directors have extensive, specific duties. Put shortly, directors are required to maintain accounting records and to prepare accounts. A company must also prepare a directors’ report containing a business review (not required of a certain size of company) and quoted companies must prepare a detailed directors’ remuneration report. Subject (principally) to a size-based exemption, these accounts and reports are subject to audit. The audited accounts and reports must be sent to members and filed on public record; there are however provisions facilitating the sending to members of a summary document and the filing, for certain sizes of company, of cut-down or abbreviated versions of the accounts. Where these accounts and reports are found to be defective, the Act facilitates revision. In addition to these duties under company law, other requirements can arise in relation to accounts and reports by virtue of market or regulatory rules, such as in relation to corporate governance codes or half-yearly reports.
The message is clear – all company directors, no matter what size the business, or sector, or whether they are executive or non-executive, need to have a basic financial understanding.
As a company director, how well do you understand:
- Profit and Loss Accounts?
- The Balance Sheet?
- Financial Ratios?
- The Solvency Tests?
- What EBITDA means?
If you have difficulty with any of the above financial items or terms then you should brush up on your financial skills and knowledge to ensure that you are discharging your duties as a company director in line with the law.
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