Financial markets are proving themselves to be highly irrational at present. Take the FTSE 100 as example. This is the chart for this year:
Markets were very happily over-valued by pretty much general consent at the start of the year. Coronavirus disturbed the cosiness of the arrangement. As people panic bought the markets panic sold. But now, every day the markets look for signs of reassurance - most of them provided by the clearly fabricated news on the number of UK deaths that dramatically understate what is happening that is issued by our government each day - and try to edge back upwards. Their belief is that it will not be long before we are 'back to normal'. The age-old belief that 'it will all be over by Christmas' (or in this case, the summer holidays), persists.
I'm not being so bold as to forecast when the threat from coronavirus might be over: I simply do not know, although I suspect it is not anytime soon.
What I can be sure of is that the impact of this crisis on markets is being significantly understated by those with short term mindsets who populate our financial services sector. They are still in for the most rude awakening. There are numerous reasons for thinking that this is the case.
First, there is the likelihood of economic depression, or worse. I have already explained why this will happen, and is unavoidable unless the government steps in with the most massive support, which fact it clearly does not comprehend as yet.
Second, the markets themselves are providing clear indications of underlying chaos that is simply not being reflected in the FTSE valuations yet. For example, Aviva has stopped pension payouts based on property valuations that no one can be sure are real right now. It has also been suggested that £52 billion of dividend payouts may be at risk of not being delivered because the companies due to pay them need to retain cash. Tesco is paying out, but based on a government bailout of £585 million: no one knows what the backlash to that will be as yet. Thi creates further uncertainty. And there remains the fact that the small business sector on which large business depends is simply melting away right now for lack of cash.
Thrid, despite this the discussion in the FT and elsewhere suggests that 'well-capitalised companies with strong balance sheets' (I paraphrase) will survive this. There is gross naivety in such claims that needs explanation.
My concern is that very few people in financial markets seem to have any understanding of balance sheets, or the transmission mechanisms that exist between them that make it clear that no company is now well capitalised in its own right: they essentially stand or fall largely as a whole now.
Under the rules of International Financial Reporting Standard accounting introduced by the International Accounting Standards Board at the behest of the European Union in 2005 assets on balance sheets ceased to be valued at their cost to a company, less any necessary provisions for their write down in value because of use or because prudence demanded it when there were real doubts as to actual worth. Instead, assets have been (in the main) valued at their market worth under 'mark-to-market' rules. So, land and buildings have been revalued. And goodwill can stay on the balance sheet without any necessary time limit. There has been a rapid growth in the ownership of assets of inherently uncertain value e.g. derivatives, intellectual proportty and financial products. In many cases there is no market for these products: they are valued by models instead. Debts are meanwhile stated at market worth, as are liabilities, which ash sometimes created the most bizarre accounting outcomes. And most especially, so too are pension fund liabilities accounted for in this way.
At the same time as this has been happening there is clear evidence that companies have been paying out their earnings as fast as they can. This is the issue I am looking at with Prof Adam Leaver at the University of Sheffield right now.
So there are two phenomena going on. One is that balance sheets no longer represent the activities of a company, as such: they represent the company's relative worth in the market as a whole. This means that what was once an indication of the internal strength of an entity has now become a reflection of markets in general. And second, companies have used the opportunities that rising market worth in asset valuations has provided to pay out maximum dividend payments. And at the same time, this process is exacerbated by its reflection in the valuation of their pension liabilities, which are inherently an indication of overall market values of equity, properties and debt, because that is what such funds own: they are possessors of nothing of real substance at all in almost any circumstance.
There is, then, no such thing as a well-capitalised balance sheet now: there is only a balance sheet that has been well positioned relative to the market. And there is an automatic transmission mechanism of uncertainty onto every balance sheet, and that is mark-to-market accounting. If that accounting does not undermine the integrity of a comapny's accoutning in itself it will via its pension fund: there is no escaping.
Because we do not value what a company does any more, which is what historical cost accounting did, but instead simply treat the quoted company as an exercise in financialisation largely unrelated to the underlying activity that it actually delivers in its day-to-day operations, we have ended up in a situation where companies are not valued in themselves but as part of a system as a whole. We are, then, not only incapable of telling which companies are well capitalised, because there is no way of knowing on the basis of the accounting data now currently in anyone's possession, we may have no way of putting this right within the current accounting framework.
The result is that we are not just in a little financial trouble: we are in deep trouble. And at some point markets are going to realise this. The fact that we have created what is, in effect, a giant Ponzi scheme for the benefit of directors who have got rich quick on the basis of inflating their share prices using the mechanisms that International Financial Reporting Standards provided to them under the apparent guise of shareholder value accounting is something we, and markets, are going to have to come to terms with.
I am working with colleagues on this issue right now, and we are coming up with answers on how to address the issues that arise. But none of them are comfortable for markets, accounting and governments. We recognise that the supposed reporting of value that has underpinned accounting for the last fifteen years has in fact been the mechanism to disguise the wholesale destruction of that value. And sometime soon that is going to become apparent, when current uncertainty in property, share and debt values have to hit balance sheets.
No wonder regulators are giving companies more time to report their financial results right now: they know that if they were required to report at present the proverbial would hit the fan. But there is no delay that is now going to prevent that happening: fundamental asset revaluation will happen in the post-coronavirus world, and no company and no market is going to survive that unscathed because all their accounting is now about their market value, and not about their inherent worth, and the two are fundamentally different things. The probelm is that for fifteen years we have been measuring the one of least importance and have been treating it as paramount. And now that is going to catch up with us.
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“the clearly fabricated news on the number of UK deaths that dramatically understate what is happening that is issued by our government each day”
The UK Government is deliberately falsifying death figures?
A bold claim.
What evidence do you have of this? Any at all? Is medicine an area where you have any knowledge at all?
I am entirely happy with the claim
The figures are seriously delayed with no attempt at correction to the time series being made, but that is not made clear
They do not include deaths in the community, and that is not made clear
And they do not cover all unexplained increases in deaths at this time
These minor issues (if that’s what you think they are) apart they’re spot on
Alternatively, they’re CRAP – completely rubbish approximations to the truth
“And they do not cover all unexplained increases in deaths at this time”
Because there has not been an increase in total deaths in England & Wales.
Total deaths (All causes) recorded to week 13 in each of the last three years in England & Wales (source ONS) – freely available to those with an interest in the truth:
2020 – 150,057
2019 – 146,018
2018 – 164,625
So 2020 is slightly higher than 2019 but much lower than 2018.
You have no evidence at all and are making dangerous and unfounded allegations which may cause unwarranted alarm – perhaps that is your intent . At a time of emergency in your country you should be ashamed. You have no education in this subject. It shows. It is your allegations that are ‘crap’.
With respect, the medics I know would profoundly disagree with you
And remember ONS data is also out of date – due to lags in death registrations
Time will tell
But if you think I am so wrong, why are so many morgues being built? And why have body bags run out in some places?
I am sorry – but all the evidence suggests that it’s you who is talking nonsense here
Hans Gruber (Dr) says:
“The UK Government is deliberately falsifying death figures?”
And why not ? It would seem the government is happy enough to function on the basis of fantasy figures in many other respects, why would you expect these figures to be accurate ?
I now doubt the figures on ITU as well
I strongly suspect these are not rising because they are saying people being ventilated off ITU, but who are getting the same treatment as they would do on it are ‘not on ITU’
I really do not trust what is being said, as you might note as a result
Deaths by week are important. Deaths for each week up to the middle of March are slightly below the 5 years average. For w/e 27 March they are 1000 or 10% higher than the 5 year average.
Given the uncertainty of diagnosis outside hospital (no testing), the time lag to registration and the fact that these figures do not include the recent huge increase in deaths in hospital, I believe the Govt. is trying to spin it by giving the lowest defensible figures for deaths. In effect they have set themselves a “target” of 20,000 deaths are trying to keep published figures well within it so that they can later claim success.
https://www.ons.gov.uk/peoplepopulationandcommunity/birthsdeathsandmarriages/deaths/datasets/weeklyprovisionalfiguresondeathsregisteredinenglandandwales
An FT journalist was speculating that deaths are five times higher than reported this morning
Weirdly I was in the middle of a business school course at Northwestern Uni, Chicago on BlackMonday 1987 when the market crashed. Chicago, home of monetarist and market thinking.
A number of us, all from the small European group present, had a riot tearing into the lecturers on how on earth IBM today could be worth 35% less of what it had been worth a few days before, when as they had been telling us, markets could price so accurately.
I knew it was rubbish already having worked with City institutions and seen how little they knew about the industry I worked in (IT – when they UK had major IT companies – which the City would not invest in).
It’s only got worse since then – ignorance as about real ‘worth’ as you put it Richard, combined with arrogance about their own opinions. Our old friend Dunning- Kruger again. All about wealth extraction and little about real value creation and innovation for wider society. The City for me is the root cause for most of the bad behaviour in the wider business world as directors dance to the City’s tunes. Start there if you want to change business for the better.
There is a lot to do here Robin
I am working with a great team on it
And there’s not a lot else to do this weekend…
More detail here on why the stats each day are not accurate.
https://www.cebm.net/covid-19/reconciling-covid-19-death-data-in-the-uk/
Thanks for that. One of the links in that research is to “tracking morbidity rates” which is also interesting. It would seem that on average in the UK (outside these exceptional times) over 10000 people die each week. I had never thought about how high that number might be in normal times.
I wonder whether some people would be more compliant with, and accepting of the containment measures if they had more sense of how much exceptional death CV is involved with in comparison to the norm.
The Government is falsifying death figures? Presumably this will be the reason declared for when your 10,000 deaths a day scaremongering a week ago proves to be wholly inaccurate.
We are not there yet, I admit
It seems lockdown has worked to some degree
But that the figures supplied are gross underestimates is, as far as I am concerned, beyond any dispute
Any informed person knows that
Scotland is making an effort to get better figures on deaths, etc:
https://www.bbc.co.uk/news/uk-scotland-52214177
and this from the National Registers of Scotland analysis:
Over the past five years, an average of 1,098 people died in the first week of April. This year the figure had risen to 1,741, although the report only linked 282 of those deaths to Covid-19.
———–
So there are around 350 extra deaths that are not listed as COVID19 but are extra compared to the 5 year average. They could be COVID deaths not recognised as such, or deaths because e.g. other illness is being neglected, or more likely a mixture.
This last point is really important
For example, care homes are simply not allowed to send people in now …. and so they are dying
There are also cases noted now of people not going to A&E and dying…
Covid deaths are bigger than those directly attributed to it
Just waiting for the ‘they would have died anyway’ rationale to pop up…
It will….
The discussion on death count reminds me of bits of Charles Eisenstein’s sprawling meta-philosophical take on the pandemic,
https://charleseisenstein.org/essays/the-coronation/
In particular where he says:
“Minimizing deaths means minimizing the deaths that we know how to predict and measure. It is impossible to measure the added deaths that might come from isolation-induced depression, for instance, or the despair caused by unemployment, or the lowered immunity and deterioration in health that chronic fear can cause. Loneliness and lack of social contact has been shown to increase inflammation, depression, and dementia. According to Lissa Rankin, M.D., air pollution increases risk of dying by 6%, obesity by 23%, alcohol abuse by 37%, and loneliness by 45%.”
https://charleseisenstein.org/essays/the-coronation/?_page=4
And as well as the focus on the death count, how about a discussion on the ground conditions which might make one population more vulnerable than another?
“To understand the point about ground conditions, consider some mortality statistics from Italy (from its National Health Institute), based on an analysis of hundreds of Covid-19 fatalities. Of those analyzed, less than 1% were free of serious chronic health conditions.
Some 75% suffered from hypertension, 35% from diabetes, 33% from cardiac ischemia, 24% from atrial fibrillation, 18% from low renal function, along with other conditions that I couldn’t decipher from the Italian report. Nearly half the deceased had three or more of these serious pathologies. Americans, beset by obesity, diabetes, and other chronic ailments, are at least as vulnerable as Italians. Should we blame the virus then (which killed few otherwise healthy people), or shall we blame underlying poor health? Here again the analogy of the taut rope applies. Millions of people in the modern world are in a precarious state of health, just waiting for something that would normally be trivial to send them over the edge. Of course, in the short term we want to save their lives; the danger is that we lose ourselves in an endless succession of short terms, fighting one infectious disease after another, and never engage the ground conditions that make people so vulnerable. That is a much harder problem, because these ground conditions will not change via fighting. There is no pathogen that causes diabetes or obesity, addiction, depression, or PTSD. Their causes are not an Other, not some virus separate from ourselves, and we its victims.”
The key point, I think, being this:
“Of course, in the short term we want to save their lives; the danger is that we lose ourselves in an endless succession of short terms, fighting one infectious disease after another, and never engage the ground conditions that make people so vulnerable.”
Honestly, what are you talking about?
Are you seriously trying to tell us that you value a company based on it’s balance sheet?
And what is wrong with mark to market accounting, which simply means you have to value assets and liabilities at their current market prices? What someone will actually pay for them.
You are aware of all the contradictions in what you just posted, aren’t you?
Why not actually engage with what I said?
Charles are you seriously saying that someone’s (who?) estimation of a company’s worth (i.e. a statement of NOTIONAL values) is a better indication of the health of a company than a statement based on provable ACTUAL events (i.e. REALITY)? By all means show the estimated market value as a supporting document, but this must be clearly identified as an estimated position which should identify who has arrived at it and by what methodology.
Whatever happened to the old dogma of Turnover = Vanity, Profit = Sanity, but Cash Flow = Reality?
Thanks Ken
Nobody values a company based on it’s balance sheet. The balance sheet is just a backward looking statement of a company’s assets and liabilities. It tells you nothing about turnover, revenue and very little about profitability.
It doesn’t tell you anything about the future.
So thanks for making my point for me, Ken.
Are you seriously telling me that you should value a company based on it’s balance sheet, or that the market does as a whole?
By the same logic, you are ignoring all the future profits of a company, as they don’t appear in the balance sheet. Don’t you think they are quite important?
There are plenty of companies out there with strong balance sheets, but weak or no profitability. There are also companies with weak balance sheets but strong revenue streams (just look at Amazon for its first 10 years).
You can’t accurately predict the future, which is why we have mark to market accounting (to say what things are worth in today’s present value terms) and why a company is worth what the market prices it at, because the balance sheet is only of marginal consequence when valuing a company in comparison to it’s future revenues and earnings. People take a view on that, some think a company is cheap, some expensive and hey presto, a market in the value of the company is born.
This is very basic finance. I’m surprised a “Professor” doesn’t know this, and seems to think that the balance sheet is the most important thing in company valuations.
You do, I presume know that the balance sheet is the dominant statement in IFRS accounts?
And that the income statement is designed to indicate movement in balance sheet worth, not profit?
If you don’t then you really do need to go and learn some basic accounts
And I did not for one moment say what you suggest: I said balance sheets are valued at mark to market values
If you knew just a little more than almost nothing, which is very obviously what you do know, you’d realise how foolish your claims are
I suggest you go and do some studying
Ken and I have
You are the one who in your article keep mentioning balance sheets and company valuations in the same breath. I think it is because you don’t understand the difference between mark to market accounting and market valuation through price discovery. Reading your word salad of a post again you seem to think the two are related, which leas you to link MTM to the values of assets on a balance sheet, then to the market value of a company. Just becaue they both have the word “market” in them doesn’t mean they are the same thing.
For example:
“One is that balance sheets no longer represent the activities of a company, as such: they represent the company’s relative worth in the market as a whole”
Balance sheets never represented the activities of he company. They only ever represented the value of it’s assets and liabilities at a given point in time.
“Because we do not value what a company does any more, which is what historical cost accounting did, but instead simply treat the quoted company as an exercise in financialisation largely unrelated to the underlying activity that it actually delivers in its day-to-day operations”
We do value what a company does. Through the profit it makes and will make in the future. Only problem is that we can’t accurately predict the future. So we let the market decide the price organically, through what they will buy and sell the shares for.
You would have thought a chartered accountant would know this.
You also keep waffling on about uncertainty and mark to market accounting. What is the problem with it? You mark what something is worth according to the current price of that asset in the market. If it is illiquid, there are models and rules for accounting conservatively. Your issue seems to be that those prices might not accurately reflect the prices of those assets in the future. Well, shucks, who’d have guessed. We can’t predict the future, not that balance sheets ever try to do such an assessment. As I said, they are backward looking. They only tell you about the health of a company at one particular point in time.
That is still significantly better than historical cost accounting, which means something gets marked on the balance sheet at it’s original purchase price. never to be changed again (other than depreciation). You think this is a better method? If asset prices are falling it is the accounting equivalent of sticking your fingers in your ears and pretending you don’t hear someone. It’s open to abuse in a way that mark to market isn’t which is why accounting has moved away from it as much as possible.
Yet here you are arguing we should go back to it! You couldn’t make it up.
I suggest you read my reply go Jorge just posted
You early have not a clue what you are talking about
I suggest you go and find out what accounting is all about. Ken appears to me to be one of those accountants who does know. I have no idea who you are and whether you are an accountant or not, but it seems you have done first term training alone and are drastically over-confident in your abilities as a result.
And for the record, we do most certainly need to go back to HCA, because it reflects what we should expect entities to be about, when adapted by SCA. I explain that in my post in reply to Jorge.
“Nobody values a company based on it’s balance sheet. The balance sheet is just a backward looking statement of a company’s assets and liabilities. It tells you nothing about turnover, revenue and very little about profitability.”
A P&L Account is a backward look at profitability. In addition the P&L Account is subject to myriad potential provisions, adjustments and abstract amendment; the effect of these abstract adjustments may be enormous. The business world has demonstrated many examples of catastrophe, when the gap between reality and interpretation becomes untenable; on a world-scale 2008 is only one of the more memorable from a long, long list. Worse the whole basis of the P&L Account is subject to the fundamental ‘going concern’ assumption; an intellectual concept that has more holes in it than a sieve; and was orginally a tortuous and implausible attempt to turn closed ventures into perpetual entities, and make some sense of measuring the effect. Oh, and I have not bothered to mention the credibility that may be placed in the “predictions” made of future profits in the business community. I promise they would not pass muster as a vague, whimisical guess in ‘hard’ science. There is no great harm if the conventions work very well, but do the current conventions “work” well? less well than you appear to believe.
I admire your naivety, if only “pour encourager les autres”.
The balance sheet is now a forward looking statement – because it reflects the discounted value of future cash flows estimated by usually overly optimistic directors who are completely conflicted when undertaking the task as their own bias rewards them handsomely
Thank you, Richard (I learn something every day). Would I, however not be correct in saying that company’s are now advised to give a Forward Statement Disclaimer, whenever they make any statement or provide a quantfication on any statement they may make about the business’s future, from a long list; including, projected financial performance, growth plans, finance, future liquidity etc., etc? This rather puts the whole picture in a clearer perspective for the accounts user.
Albeit it does not help Charles very much…..
They are…but they’re about as much use as chocolate tea pots in my opinion
Am I merely being mischievous if I suggest the word “disclaimer” usefully points the reader, who may be busy on the preliminaries to boiling a kettle, to the prospect that the teapot may be derived from cocoa? Is this an argument for drinking coffee?
Half-shot latte for me! Two-shots and I would start pacing up and down worrying about chocolate teapots.
🙂
In response to Charles’ post at 7:11pm, a company’s balance sheet is a statement of the company’s assets and liabilities as at a specified date and makes no pretence at “forecasting” the future. You write “It tells you nothing about turnover, revenue and very little about profitability”. Well of course not: these are recorded in the Profit & Loss A/C.
Clearly your knowledge of accountancy is very limited if you don’t understand this, just as it’s betrayed by your imagining that my post somehow endorses your view. Your faith in the magical powers of some unspecified person or body to make predictions (more accurately they are guesswork, pure and simple) of a company’s future profits and net asset position is simply beyond rational comprehension.
As you yourself point out “You can’t accurately predict the future…”, but you seem to be suggesting that this should be the basis for annual accounts reporting. Accountants have to deal with facts (the reality) and logically the accounts have to reflect that — they can proved by audit. How do you propose that the guesswork of future cash flows, profitability and net assets, with the multitudes of inherent variables, might be audited?
There is no doubt that the content of published accounts could be enhanced and improved, particularly by recognising that the interests of a wider group of stakeholders than just shareholders should be catered for. However, my view is that statements of future net worth should be confined to the Directors’ Annual Report, with supporting evidence from e.g. forward order books etc.
Agreed Ken
Arguing that the valuation basis of the balance sheet is wring does not in any way lead t the conclusions some are claiming here
I rather suspect that someone, somewhere has been winding their audience up with claims that this is what I said. I never look at Tin Worstall’s blog, but I suspect he’s written some of his usual drivel. It has all that feeling to it. And he really does not understand accounting, at all, but his readers have blind faith and turn up he to do his bidding
I’ll add to my last para about the need for improvement in the scope of reporting in corporate accounts. There is also a pressing need for improvement in the quality and scope of the auditing of these accounts. Large company audits have become a global closed shop and standards have dropped as a result.
I agree
See the recent report by Leaver, Seabrooke, Wigan and Stausholm on this issue from the University of Sheffield
Of course turnover, revenue etc are recorded in the P&L statement. But you and Richard are fixating on the balance sheet, and he especially is claiming it is something that it is not.
“Your faith in the magical powers of some unspecified person or body to make predictions (more accurately they are guesswork, pure and simple) of a company’s future profits and net asset position is simply beyond rational comprehension.”
Really? Who does this? Anyone with any knowledge of accounting knows this is just nonsense. You betray your lack of understanding here.
Predictions of future profits don’t appear or belong anywhere in company accounts. They might appear in an annual reports, but they are just predictions, and are unaudited as such. No value is directly attached to them in accounting terms. The value of the shares in a company is related to what people think those future profits may be, but, as I keep saying, there is no way to accurately predict the future.
It’s net asset position will appear in company accounts. Many of those line items will be at fair value, otherwise known as mark to market. That means that a future (but guaranteed) cashflow will be priced in present value terms, based on today’s interest rates. There is no prediction involved.
To make this very clear for you. A defined cashflow at a given future date (be it asset of liability) is already considered contractual. Therefore it appears in the accounts. Because it is a future cashflow, and we know that it doesn’t have the same value as a current one. The only fair way to deal with this is to present value it. We do that using the current, observable interest rate curves.
This is accountants dealing with the facts and reality of the current situation. No audit is trying to make any claim that it is a statement of how much a company will be worth, it is simply a statement of the accounts as they are at a given point in time, with future values discounted by observable means. There is no guesswork involved.
You can’t seem to get your head around the idea that you don’t have to guess about how much something is worth in the future, because it has a price and a discount curve today. That is different from saying it’s price will not change (which of course it will), but audits and accountants are not trying to predict those changes. All we care about is how things are at a given point in time.
Are you seriously trying to tell me that it should go into the accounts at it’s full value?
Or that historical cost accounting, which leaves assets on the balance sheet at their original price is somehow better? The reason it is not used much any more is that it is so open to abuse.
“However, my view is that statements of future net worth should be confined to the Directors’ Annual Report, with supporting evidence from e.g. forward order books etc.”
QED
Charles
I hope you have heard the advice that when in a whole, stop digging? You should have done….
First, it really does seem as though you do not know that the P&L account is simply the way that changes in balance sheet worth are recorded (excepting additions to share capital and withdrawals of shareholder funds). You do need to appreciate that. As such, how value is recognised on the balance sheet is critical to P&L measurement. Your failure to appreciate this is pretty telling.
Second, if you really think that there is any certain future income stream, excepting payment on a very limited selection of government securities, then you are quite staggeringly naive. To presume that there is certainty in such things, to which a certain discount rate can be applied, is so staggeringly stupid post 2008 (read para 1.4 of the Turner Review of 2009) that anything else you say is quite absurd.
Excepting that, third, you think there are no assets valued on the basis of estimation of future cash flows on a balance sheet. Estimation is absolutely at the core of accounting. Even the appraisal of trade debts under HCA requires this, for example. And stick and WIP does whatever system of accounting you use. Sorry to show my frustration, but your ignorance of accounting reality is quite staggering.
I have said it before, but before you point again try to learn something of what you are talking about. You are clearly clueless on accounting.
Richard
It is very clear you don’t understand the difference between a known future cashflow or asset, valued today and the future, unknown price of a given asset.
What you say gives this away.
I am not and have not been talking about valuing unknown future cashflows, from as yet unrealised transactions.
I AM talking about valuing known cashflows which will occur at some point in the future.
For example, if a company sells some product, but will only be paid in arrears (very common), the company must account for these revenues immediately. Not when the money comes in. Because the cashflow is in the future, you can use the KNOWN interest rate curve to discount that future KNOWN value to a present value.
That does NOT mean that value will be exactly the same tomorrow, because the interest rate curve may have changed.
“Second, if you really think that there is any certain future income stream, excepting payment on a very limited selection of government securities”
If the income has already been earned from current sales, then it is certain (allowing for default) and must be accounted for. If it is a projection not based on completed business, it is purely a projection and is not accounted for.
For your guide, even government securities change in value every day and the same notional sum of bonds on a balance sheet will give you different values based on the market price of the bond on any given day.
“To presume that there is certainty in such things, to which a certain discount rate can be applied”
Again, accountants are NOT trying to predict the future. All we are doing is valuing assets and liabilites given CURRENT market rates. Today. Not what they will be in a years time.
“Excepting that, third, you think there are no assets valued on the basis of estimation of future cash flows on a balance sheet. Estimation is absolutely at the core of accounting”
Again, you are wrong, by confusing estimation and the present valuation. The estimation comes when a contractual future cashflow might not be certain, for a number of reasons – like i said default is one. Accountants will estimate the value of that future cashflow, given the considerations of the issues surrounding that cashflow. Then they will present value it, which requires no estimation.
Your problem seems to stem from conflating the future with estimation, and not understanding that balance sheets aren’t trying to predict the future. They are trying to show things as they stand today.
But by all means, tell us how you would solve this problem. Are you saying that we should estimate all of a company’s future profits, as yet unearned, and put that on the balance sheet as well? Or are you saying that we should just ignore present value and market prices altogether and rely totally on historical prices? Which will inevitably be wrong. How would you deal with a receivable of £X set a few years in the future, in that case?
It must be wonderful to live where there is only risk and no uncertainty
In the real world there is both.
You clearly haven’t realised as yet
Please don’t call again
The markets still seem to have an elements of fear about them – which manifest itself as volatility.
– see here for some crazy stats about the last 6 weeks movements on the Dow Jones…
https://en.wikipedia.org/wiki/List_of_largest_daily_changes_in_the_Dow_Jones_Industrial_Average
Until the volatility subsides I will suspect the market hasn’t fully adjusted.
The fear most people forget is FOMA, and Richard, I suspect that is one factor in keeping the market above where you think it’s value lies.
Not only do I agree with the headline of this post, I think that Covid-19 has revealed just how close to the wind many companies are flying – in other words the financial health of many of them is hopelessly over stated by standard accounting practice.
What sickens me is that the same society that allows credit default swaps and poor accounting standards to exist is also the same one that denies the plausibility of MMT.
@ Pilgrim Slight Return?
What is the problem with credit default swaps, which allow firms to protect themselves against the default of other companies?
If you have not realised by now you never will…..
Read some history
Here is one for you Richard.
This is Tesla’s balance sheet, as of the 31st Dec 2019.
https://finance.yahoo.com/quote/TSLA/balance-sheet/
How was Tesla worth on that date, and how much is worth today?
You have balance sheet, so by your logic that should be all you need to know
You know very well you are asking a stupid question and that this was not in any way at all what I was saying
If you don’t, you’re the fool because you have no comprehension of what the accounts mean and are revealing the fact
So what does the balance sheet mean? I understood your blog to mean it has something to do with the financial valuation and strength of a company. If that is not the case, what does a balance sheet tell us?
It should tell us how a company has used the assets entrusted to its care.
All balance sheets have a capital maintenance concept inherent in them – although very few accountants seem to understand that. It’s certainly not widely taught.
IFRS accounts seek to maintain financial capital, thence the valuation of assets at financial worth.
In contrast historical cost accounts seek to maintain physical capacity of the firm – and so states assets at the cost of that capacity to the enterprise.
Sustainable cost accounting seeks to maintain the environmentally sustainable presence of the firm and reflects the cost of doing so.
The balance sheet is then a basis for accounting decision making, if you understand what it and its necessary relationships with the P & L account and the cash flow that should reconcile the two might be.
But unless you understand what it is the firm is trying to achieve then the balance sheet does not make sense. IFRS is about pure profit, regardless of value. The balance sheet is transient; the values every changing to the wills of the market. It sees the entity as simply a player in a larger game in which it is simply an agent for arbitraging value for its own expropriation.
HCA is about delivering value for society – the entity has a purpose within it. That purpose is service, and its maintenance or continuation, hence the concept of prudence: taking action to ensure continuity.
And SCA is all about the sustainability of that purpose of service and as such is a natural development of HCA
The balance sheet is not a neutral statement. Nor is it an indication of worth. It is an indication of priorities and how those suggest the management of the entity has behaved. In that sense it is a measure of performance. But it is also widely misunderstood.
So, you are right: valuation is key here, but value can be perceived in many ways. And the balance sheet does not indicate value of the firm: it indicates worth of the resources in use in that firm dependent on its view of how it wishes to use them and what it wishes to prioritise as its purpose. Most of all, the balance sheet highlights that issue of interpretation of purpose in ways that other statements in the accounts cannot. As such when interpreted properly it is a measured of resilience – which is very noticeably absent in very many balance sheets right now.
Balance sheets just tell us the assets and liabilities of a company. Nothing more. They aren’t intended or designed to.
Historical cost accounts don’t seek to maintain the physical capacity of a firm. HCA just puts the cost of an asset down at purchase price, less some depreciation. HCA is not used any more for the most part, because it is just so far out of touch with reality most of the time. Asset prices change all the time, and most assets don’t just depreciate on a simple or formulaic basis.
Aircraft are a good example. Under HCA that jet would be on the balance sheet at full cost, minus some depreciation. Which would be look ridiculous today, as aircraft are in a massive surplus thanks to the lockdowns, and are worth much less than their original purchase prices thanks to the massive supply available.
You say the balance sheet is the basis for accounting decision making. Last time I checked it was not the accountants or auditors who make decisions, and the BS and the PNL statements were just snapshots of the current state of the business.
You also say that you need to know what a firm is trying to achieve to make sense of the balance sheet. This is just nonsense. The balance sheet is not designed to tell you the nature of a business. If you took the names off the top, most would look very similar, in structure at least. It tells you nothing about the nature of the business and nothing about it’s profitability. And of course balance sheets are transient. Things change all the time. Do you expect balance sheets to stay the same?
HCA has nothing to do with “delivering value for society”. It’s just a way of assigning financial value to given assets. In that respect it is no different to mark to market accounting.
Not sure what SCA is, but balance sheet accounting is about valuing assets in financial terms, not about their value to society. Why is it this way? Because financial terms are easily translateable to a common denominator, money in this case. Value to society is purely in the eye of the beholder. It is totally subjective, depending on who you ask. Do you think that is a sensible approach to accounting? It would lead to ridiculous results.
Balance sheets are not an indication of priorities, or of worth as you finally acknowledge. They are only a statement of assets and liabilities. Nothing more.
Your last paragraph is mind boggling.
“So, you are right: valuation is key here, but value can be perceived in many ways. And the balance sheet does not indicate value of the firm: it indicates worth of the resources in use in that firm dependent on its view of how it wishes to use them and what it wishes to prioritise as its purpose. Most of all, the balance sheet highlights that issue of interpretation of purpose in ways that other statements in the accounts cannot. As such when interpreted properly it is a measured of resilience — which is very noticeably absent in very many balance sheets right now.”
As I said earlier, valuation is done in purely financial terms to avoid subjectivity. You don’t think Banks have much value to society. Does that make their assets and liabilities less valuable now? Balance sheets can tell us a bit about the resources available to a firm, but it tells us nothing about how it intends to use them. There is literally no “interpretation of purpose” going on inside balance sheet accounting.
I’m shocked that an accountant and supposed expert is making these farcical claims about simple balance sheets.
Jorge
With the greatest of respect, ignorance of reality on such a scale is really not worth engaging with.
I can you summarise my response in three words: you are wrong.
If you wished for a fourth it would be: you are completely wrong.
Please don’t call again
Richard
As if to underline your title assertion:
the FTSE rises by 7.8% in a week (highest weekly rise since January) when the Prime Minister is in intensive care!!
There are aspects of an organisation (not just businesses either) which balance sheets, P&Ls and the market neither capture nor understand. I’d argue that the over-focus on financials and financial reports is at the heart of many of the problems with today’s capitalism
In a real business (and not just businesses), it is the people, the systems and processes, the accumulated knowledge together with relationships it has built up with its customers which are its source of strength every bit as much as what the balance sheet and P&L might say. Its not either or. Todays traders and analysts, staring at their screens or sitting in wine bars in the City know little or nothing of that. Ive dealt with them and been in those wine bars… (yes there are a very few honourable exceptions)
Financialisation has meant that those aspects of businesses (and it applies to public sector organisations too) are ignored or discarded. People are merely seen as commodities to be bought and sold. Core capabilities are outsourced to make the books (and directors bonuses) look better. Been there, done that, multiple times. Investment in people, systems and processes, R&D, distribution is cut to the bone leaving those organisations weakened and vulnerable, just as loading them with debt does the same.
Sorry bean counters – there’s a lot more to life than financial reporting. Though Id agree that must financial current financial reporting is somewhere between unhelpful and downright misleading
(retreats behind sofa…)
Good bean counters agree
Bad ones do not
The worst cannot understand that the business and the entity are not the same thing – the business being bigger than the entity, but the entity being the thing that reports financial data and which in turn is subject to financialisation
This sounds worryingly like accountants arguing about the prices they put on everything. Whilst failing to understand the value of what might really matter.
Which if you are a City orientated accountant is all that they are concerned about.
That and trying to create certainties and ignore significant real world uncertainties. Just those deluded economists with their models.
Ill carry on assuming that reports and accounts are the works of fiction and presentation that they’ve been for years.