Whether or not in a conscious manner, management uses budgets, balance sheets, and income statements for the same purpose aeronautical engineers employ phys- ical models and digital simulators of aircraft. The budget predicts the anticipated outcome of a business strategy, and:
● Ifthe projected results are unsatisfactory
● Thenmanagement can alter some of the variables, and financial allocation made to them.
Because proper budgetary analysis helps in providing insight, as a financial plan the budget must play a much more dynamic role than the one it is usually allo- cated in business and industry. For instance, the sales budget (see section 6) pro- vides the basis for a polyvalent projection of income by:
● Indicating the physical quantity of units expected to be sold over a given period, by price tag
● Providing an analysis of these units by market and currency, in case of multinational operations, and
● Presenting a quantitative estimate on which to compute market risk, coun- try risk, currency risk, and associated hedging possibilities regarding income.
The reader’s attention has also been brought to the fact that budgetary analysis helps in walkthrough on managerial decisions, regarding issues involved in
allocation of funds as well as in performance. This makes feasible a factual level of experimentation in regard to a number of queries that invariably arise with all issues connected with financial allocation.
Spreadsheets have been used since the early 1980s in providing an interactive means for answering What Ifqueries. The challenge now is to include sophisti- cated knowledge artifacts, therefore more intelligence, into the software. In budg- eting and budgetary control, like in so many other activities, expert systems are
‘assistants to’ the executive, and therefore his friends. Their presence should supplement, not substitute human judgment.
Simulation of financial allocation and expected performance should be based on alternative scenarios. Corporate financial models are instrumental in projecting the economic results. They accomplish this mission by translating the budget process into a series of algorithms which permit experimentation.
● Assumptions made about the future, and expressed in an algorithmic form, are tested against real-life scenarios.
● The results obtained can be interactively investigated so that corrective action is taken in time to bring the budgetary process into shape.
‘The purpose of any organization is to achieve output,’ Dr Andrew S. Grove, Intel’s former Chairman, once said; whether it is widgets being manufactured, bills mailed out, loans processed, or insurance policies sold. ‘Yet, in one way or another we have all been seduced by tangents and by the appearance of output,’
Grove suggested.
To separate the real output from the imaginary, we need measurements and met- rics. This is precisely the function to be fulfilled by a budgetary analyser. The more classical and less sophisticated types of budget analysers are simple quan- titative models. Because, however, qualification is important with any financial plan, more recent approaches introduce a certain number of judgmental factors, including risk and uncertainty (see section 4 on alternative budgets and section 6 on budgetary bandwidth).
The budget analyser is not just a quantitative tool, as many people believe.
Sophisticated approaches involve both qualitative and quantitative factors, with the output expressed in expected value and limits, according to the General Electric method (see section 5). Whether we talk of budgets, or of anything else, numerical values are important – but they are only part of the story. The neces- sary supplements are:
● Qualitative factors, and
● Personal vision.
In his excellent book Adventures of a Bystander, Dr Peter Drucker mentions a story about Henry Bernheim, the man who started from nothing and made one of the most important merchandising chains in the United States at the end of the 19th century. Bernheim had sent his son to the then new Harvard Business School to learn the secrets of management – both theory and quantitative methods.
‘But father,’ said the son when he returned from higher education, ‘You don’t even know how much profit you are making.’ ‘Come along my boy,’ answered Henry, and he took his son on an inspection of the flagship department store’s top floor to a sub-sub-basement which was cut out of bedrock. There, at rock edge, lay a bolt of cloth. Contrary to what business schools teach, there were no statistics around, no budgets, no balance sheets, and no income statements. Just the bolt of cloth. ‘Take away all the rest,’ said the father, ‘It’s the profit. This is what I started with.’2
Notes
1 D.N. Chorafas and Heinrich Steinmann, Expert Systems in Banking, Macmillan, London, 1991.
2 Peter F. Drucker, Adventures of a Bystander, Heinemann, London, 1978.
10
Valuing Assets: The
Challenge of Being ‘Right’
1. Introduction
As every businessman knows, it is essential that company assets are properly valued, and that their value is not only computed in a fairly accurate manner, but also stated in terms that reflect the dependability of numbers being given. This is the fundamental sense underpinning fair value, which must be individually calculated for every asset. It cannot be guesstimated in an overall averaging process.
From the viewpoint of modern managerial accounting, it is the detail of a spe- cific asset or liability that makes the difference between fairly accurate and rather inaccurate value estimates. Whether for planning or for control, the pres- entation of managerial information must not only look reliable, but also be reli- able. Otherwise, it is worse than nothing.
Through policies, practices and procedures in valuing assets under different accounting regimes, as well as by means of case studies, this chapter demon- strates how and why both US GAAP and IFRS serve as infrastructure for reliable value information to be used in management accounting. In essence, the new rules:
● Bring general accounting, financial accounting, and management account- ing closer than they have ever been before, and
● Open new management accounting perspectives through high technology, as will be documented in Chapter 15 with the real-time balance sheet.
Valuing assets through fair value provides a common denominator for practically all types of reports. Single-handed, it does not make everybody a great entrepre- neur. On the other hand, as it should be recalled, the corporate raiders of the 1970s and 1980s made good use of their ability to valuea company’s assets bet- ter than the market did. Along with this, they capitalized on innovations in financial instruments. On both sides of the Atlantic, with borrowed money they:
● Set about buying companies undervalued by the market, and
● They created usually leveraged conglomerates which they sold at a premium.
For evident reasons, corporate raiders preferred dull, undermanaged businesses in unglamorous sectors of the economy, particularly when they saw firms valued by the stock market according to historic prices of their assets, rather than their (more valuable) potential to generate cash. And they got ahead of the curve by
realizing that fast-growing debt markets were willing to lend large sums against future cash flow. Behind the corporate raiders’ success lay the fact that:
● The right valuation at the right time creates business opportunities, and
● In the markets of late 20th century buying an undervalued firm, even through lots of debt, could quickly pay for itself.
Another important element in the success of corporate raiders in the 1970s and 1980s, and through the 1990s, was that they saw many big firms were not run in a way to maximize shareholder value. Mismanagement, or at least poorly focused management contributed mightily to these companies’ low valuation. This was especially true of diversified, strategically driven conglomerates which had lost their original animator – and therefore their soul.
The message the previous paragraphs convey is that quality of management is one of the crucial elements in giving assets their value – as well as in recogniz- ing undervalued assets. In the hands of sharp, hard-working operators, firms were run to generate more cash. Managers in the new team that took over were loaded with incentives, and they were left to get on with the job, usually involv- ing determined cutting of such superfluities as lavish corporate headquarters and inordinate perks. The cash generated by these restructured companies went to:
● Repay debt used to fund the acquisition, and
● Deliver rich dividends to shareholders, essentially the raiders themselves.
Corporate raiders were tough operators who created their wealth by upping the value of diversified portfolios of holdings, many of them formerly sleepy busi- nesses. And they paid for the deal almost entirely by selling many of the acquired companies’ subsidiaries, leaving themselves with that part of the busi- ness that made a significant operating profit margin.
● These raiders were often likened to dealers who bought a load of junk, tarted it up and sold it with sugar-coating.
● This was partly true, but the real reason for their success was their ability in revaluing undervalued assets, creating wealth, for themselves, their companies and society as a whole.
Available evidence suggests that the originator of the fair value ‘plus’ approach has been Harold Geneen, though Thornton of Litton Industries also competes for the title. Geneen’s value concept went all the way down to sales. At ITT, sales
had no point unless they were profitable. Too many managers were dazzled by volume, and talked proudly about how many people they employed. Geneen’s answer to that was: ‘Nonsense, all nonsense.’1(More on Geneen and the raiders in section 5.)