FI­NANCE FOR NON-FINA AN­CIAL SORTS

Finweek English Edition - - COMPANIES & INVESTMENTS - PAUL MAUGHAN

IN RE­SPONSE TO

MAR­KET­ING MAT­TERS

Ac­coun­tants have the abil­ity to ir­ri­tate al­most all peo­ple sit­ting around the board­room ta­ble, see Fi­nance for non-fi­nan­cial sorts: Ex­am­in­ing the miss­ing as­sets ( Fin­week, 23 Jan­uary is­sue). Jeremy Samp­son is one such per­son and he has given a num­ber of rea­sons for his un­hap­pi­ness in his let­ter last week, which was fea­tured in the Feed­back sec­tion in the 6 Fe­bru­ary is­sue. What fol­lows is an ex­pla­na­tion of the method be­hind the seem­ing mad­ness of ac­coun­tants.

IN­TAN­GI­BLES

One of the main points made was that the most valu­able as­sets of a f irm are in­tan­gi­bles. While this is true in some cases, th­ese in­tan­gi­bles are not recorded by ac­coun­tants be­cause they can­not be re­li­ably mea­sured. If you ask one group of ex­perts to value your brand you will be cer­tain of the value. Ask another group of ex­perts to value that same brand and you start to see a prob­lem emerge − the num­bers will of­ten be vastly dif­fer­ent. Un­til there is an agreed-upon method­ol­ogy for valu­ing in­tan­gi­bles, this will be a prob­lem. Ac­coun­tants there­fore pre­fer to leave th­ese highly sub­jec­tive num­bers off the bal­ance sheet and al­low in­vestors to make up their own minds as to their value.

BRANDS

The let­ter writer cor­rectly points out that brands can be sold for large amounts. When this oc­curs, the brand will ap­pear on the bal­ance sheet of the pur­chaser be­cause the value has been clearly es­tabl ished by the ne­go­ti­at­ing par­ties and un­cer­tainty around mea­sure­ment has been re­moved.

My ma­jor cau­tion is with re­spect to t he i mpli­ca­tion t hat t he l a rge gap be­tween the mar­ket value of a com­pany (as de­ter­mined by the share price) and the as­set value (as de­ter­mined by the ac­coun­tant) is made up pri­mar­ily by ‘ brands’. That is quite sim­ply not true. In the case of mines as well as oil and gas com­pa­nies, t he reser ves sti l l i n t he ground drive a large part of the share price but yet would not be on the bal­ance sheet be­cause they are yet to be de­vel­oped. For a life in­surer, the em­bed­ded value of con­tracts al­ready writ­ten is the num­ber most closely watched by in­vestors but it is not recorded as an as­set be­cause it re­lates to fu­ture busi­ness still to be con­cluded. For a com­pany like Ap­ple, the value of the net­work cre­ated is the largest in­tan­gi­ble. This is a net­work where songs can be down­loaded, apps can be pur­chased and de­vices can be synced ef­fort­lessly. This has lit­tle to do with the brand but rather re­lates to the ecosys­tem that has been cre­ated by Ap­ple to keep cus­tomers linked into their prod­ucts and ser­vices. How valu­able is that net work? Very valu­able. How much ex­actly in dol­lar terms? It is too hard to re­li­ably mea­sure and is there­fore ex­cluded from the bal­ance sheet.

Another com­ment worth mak­ing is that not all ef­forts to build a brand lead to wild suc­cess. I am re­minded of an episode of the pop­u­lar TV se­ries Parks and Recre­ation. One of the char­ac­ters starts a busi­ness, En­ter­tain­ment 720, and spends a for­tune on par­ties and var­i­ous items of mer­chan­dise with the com­pany logo boldly dis­played. Af­ter a short pe­riod of time, with cash re­serves down to zero, the per­plexed char­ac­ter is heard say­ing: “I just don’t un­der­stand it. They say you’ve got to spend money to make money. Well, I spent all my money and I made noth­ing!” This ex­am­ple is over the top but it does dis­play the prob­lem of recog­nis­ing all ad­ver­tis­ing and mar­ket­ing ef­forts as be­ing well-di­rected and ef­fec­tive. How could you tell if a cam-

paign is go­ing to be as ef­fec­tive as Co­caCola (or any of the other great brands men­tioned in the let­ter) or whether it was des­tined to be the next En­ter­tain­ment 720? Ac­coun­tants are not qual­i­fied to do so; in fact, I would sug­gest that no-one is po­si­tioned to do so with pre­cise nu­mer­i­cal val­ues at­tached. For that rea­son, all amounts are ex­pensed and in­vestors can make up their own minds about the value of the brand.

VAL­U­A­TION

Valu­ing a com­pany is not easy. For the most part, a val­u­a­tion looks at the fu­ture cash f lows gen­er­ated by the busi­ness, cal­cu­lated in to­day’s money through the use of an ap­pro­pri­ate dis­count rate. What that means is that val­u­a­tion ex­perts are look­ing at the f uture to ar­rive at the value of the com­pany and will take into ac­count a lot of what ac­coun­tants ig­nore due to un­cer­tainly around mea­sure­ment. Should ac­coun­tants hang their head in shame? No, in­vestors are just one group of end users for f inan­cial state­ments. There are also the banks, em­ploy­ees, rev­enue ser­vices (Sars) and trade unions, to name a few.

What ac­coun­tants aim to pro­vide there­fore is de­ci­sion use­ful in­for­ma­tion to all th­ese di­verse users, with trans­parency about how the num­bers were ar­rived at. All users can then undo and re­shape the num­bers to their hearts’ con­tent in or­der to ar­rive at the num­bers that help them the most. Pro­vid­ing all this ad­di­tional in­for­ma­tion is partly the rea­son why f inan­cial re­ports have grown in length and is also the rea­son for a group to push for ex­ten­si­ble busi­ness re­port­ing lan­guage (XBRL), which pro­vides real-time in­for­ma­tion about the ac­counts as op­posed to users hav­ing to wait months for an an­nual re­port to be re­leased.

I have much sym­pa­thy for t hose un­happy with the meth­ods of ac­coun­tants but with so many dif­fer­ent con­stituents to please, it is prob­a­bly the cor­rect out­come that ev­ery­one is a lit­tle up­set with us!

Paul Maughan CA(SA) is a UCT Board Course se­nior lec­turer.

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