Business
Is Finding the Most Efficient Business Markets Illusive?
December 4, 2011 | 
Author 
When I say most efficient business markets I mean the markets that will do business with you more quickly than the others. There are quite a few things that make this possible. The first is that any business owner must define their primary market. The next important step is getting in front of that market on a continual basis which can be accomplished in person or via the internet. In this case I will discuss how this can be accomplished using the internet. Lastly it is important to understand how to place the content that your market is looking for when they are looking. Doing these three important things has been illusive to me for quite some time but now I have the advantage of the correct training and system to focus my marketing efforts so that I can achieve this on a regular basis.
First I will discuss what I have learned about defining a primary market. This obviously varies depending on the business person and the business but there are many methods that work consistently. The first is asking the right questions to define your target market. Here are the examples of the questions that I use to define my target market. What do they do for a living? What struggles do they face? What is important to them? What are their values? What is their current income? What are their income goals? What types of activities do they enjoy? What is their definition of success? Do they use any industry specific “lingo” or terminology? The key is to be able to answer these questions very definitively and specifically so you will know how to market. In addition to asking yourself these types of questions about your market you can go to different forums, social sites, newspapers, magazines, and other articles databases to see how your industry is being marketed in order to understand who is looking.
Now that you have a great understanding about what your market looks like you need to understand how to get in front of that audience on a continual basis. This literally can be done in more ways than one person can accomplish on their own. In fact the ways you choose to market to your target market depends on what you enjoy doing. Maybe you enjoy writing articles, press releases, making blog posts, participating in social media marketing. Whatever it is your results will always vary depending on a few things; consistency, and quality of your efforts. The quality is something I have spent a great deal of time focusing on. It is important to understand the tricks of the trade when it comes to getting your message to people effectively.
Now that you understand how to define a target market, and how to get in front of that market, all that is left is to understand what they want to hear and when they want to hear it. Understanding this skill does depend to some degree on how well you have defined your target market but beyond that there are some ways I will share with you so that you can begin to understand how to give your readers what they are looking for when they want it. First of all this step requires that you continually look at what the hot topics are for your area of business. To do this you can check forums, blogs, social media, or even subscribe to Google hot topics to understand what your audience wants to hear any given week. Sometimes these topics are very volatile and other times they hardly ever change; this all depends on your business. However, it is true that if you provide solutions or at least good value to the questions that are most important to your target market you have answered what they want to hear and when they want to listen. You can also use tools like Google Analytics and tracking codes on your sites to understand where your traffic comes from. Above all it is of the utmost importance to have good training to become a master marketer. It is very easy to spend a lot of time and not see results if you do not optimize the efficiency of your methods.
The bottom line to effective marketing again relies on three things. Defining your target market, understanding how to get in front of them on a regular basis, and finally giving them what they want when they want it. I know how to show people how to accomplish this because I have been trained well and I am willing to share this knowledge with you. Whether you have a business or not you can make money with these skills and then use these skills to apply to any primary business.
Successfully,
Ryan Heidrich
By: Ryan Heidrich
Determining Value in Training
How does one determine value when training? Does it seem possible that many of us have lost our ability to correctly assess the value of the programs that are delivered? I know, starting an article with two questions is not the ideal method for making an argument. Nevertheless, I am of the opinion that the value of ‘questions’ is greater than the value of ‘answers’. Therefore, I submit these questions for review
A traditional method for determining value is in the ‘content’. Many programs are built around the training content. The belief is that the ‘content’ is of such great value that irrespective of the delivery, that the student will immediately absorb the material and be capable of mastery of the topic. (At least that is how many training departments are acting in today’s corporate environment.)
I have seen training department after training department continue this error of value. It is interesting that many of these corporate training groups believe that they can take a 20-something trainer (please continue to read so that you get the point and not take offense at the example) and provide them with relevant material, and somehow that combination of inexperience and content will mix up a potent brew of high-quality-training!
Could someone please explain how this mix of inexperience and content morph into elegant training?
If the premise of this mix had any value to it, the argument could be extended to education in our universities. We all know that the professors at Harvard, Yale and other Ivy League universities publish a tremendous amount. The professors write books, articles and provide analytic case-studies that are available to just about any and everyone. How is it that with the availability of these valuable resources, that we still have great disparity of value attributed to our different university experiences? Why isn’t the local community college’s degrees of equal value to those of Harvard and Yale. If the material is the same, why should not the student come away with the same value?
This leads to the crux of the initial question: how to correct assess value in training programs.
If value is not determined by the content, then what DOES determine value? Simply, it is all in the delivery and presentation. In our university example, the professors at these esteemed institutions are just superior to those of your local community college. (In disclosure, I did not attend an Ivy League college.)These professors are at these universities because of all that they had done prior to arriving there. They were already on the forefront of the material they teach. They have been pushing the envelopes far beyond their peers in their fields. They showed that their grasp of the material was so complete that they could deliver a highly-engaging presentation to their students. In short, they could inspire their students with the material.
This brings us back to corporate training. Value, it seems, is related to the ‘trainer as well as the material’. If we are seeking to take our staffs and elevate them in performance, knowledge and conduct, we have to seek solutions to insure those objectives. Doesn’t the trainer, sometimes, make all of the difference in the world? How many times have we found ourselves interested in the material to then experience a trainer who kills our desire for it? Conversely, how many times did we find undesirable subjects take flight when a teacher/trainer was there to elevate the material?
Giving thought to WHO provides training should be of greater importance than to WHAT material should be delivered. Value is always determined by those who attend and then engage the material once they return to their jobs. Making the hard decision to deliver high-quality programs will never be easy. Nevertheless, it is the most sure way to guarantee that your training department and programs continue within your corporate walls.
By: Bryant Nielson
Posted in Business | 
Tags: Belief, Books Articles, Case Studies, Corporate Environment, Different University, Disparity, Experiences, Harvard, High Quality Training, Inexperience, Ivy League Universities, Local Community College, Morph, Potent Brew, Premise, Professors, Relevant Material, Training Departments, Valuable Resources, Yale | 
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Definition Of An Entrepreneur
The dictionary outlines an entrepreneur as somebody who initiates and assumes the risk for business ventures. However the definition of a successful Entrepreneur is something a little different.
We use information in this business, knowledge that leads to profits. Entrepreneurs make money by applying supply and demand information against an existing environment to produce a result. So even though the existing dictionary definition talks about assuming risk for the existing project, a successful entrepreneur actually assumes profits. Its the difference between a success and a failing project.
An entrepreneur studies his market and knows the current price points that investment objects will sell for. Armed with this knowledge he/she can confidently make investments and know the price negotiated is actually locked in profit. Its this intrinsic value knowledge that is so vital to an investing entrepreneur
So entrepreneurs buy profits and sell into working capital. If you were to define the absolute activity the typical entrepreneur does it would be the deal maker. Entrepreneurs deal in value and value exchange.
So to define clearly what an entrepreneur does we can say that they measure and deal in values, ensuring that their purchases are always below the value of the investment object. To do this they actually study the market they specialize in. In other words, they literally keep track of sales as they happen in there market and maintain constant vigilant surveillance so they know exactly what a given investment object (making allowances for current condition)is actually wort6h and what current perceptions are about that object.
A smart entrepreneur also reads charts of recent price movements and studies the emerging trends, to anticipate coming bubbles and troughs in the price points they currently deal in.
Martin Thomas (c)2005
By: Martin Thomas
Posted in Business | Tags: Bubbles, Business Knowledge, Business Ventures, Current Condition, Dictionary Definition, Existing Project, Intrinsic Value, Investments, Martin Thomas, Perceptions, Profits, Smart Entrepreneur, Successful Entrepreneur, Supply And Demand, Surveillance, Thomas C, Troughs, Value Exchange, Value Knowledge, Working Capital | No Comments »
Don’t Miss Out These Promotional Items
In the marketing field you need to understand that you should only go for those products that have some kind of market value. Hence, when you are looking out for promotional items to promote your business you need to be sure that the items you are providing also has some kind of market value. Hence, when you are thinking about some promotional items for your company you need to keep in mind the quality of the products and then you need to think whether the customers will really enjoy using those items. If you think that both conditions can be met then you can go ahead and gift those items to your customers.
However, there are some promotional items that have always remained in the market and you should not miss out on them because they are tried and tested products that never let you down.
If you are thinking of simple promotional items then t-shirts are the best gift that you can give to your customers. Today, there are hundreds of different companies that make their own promotional t-shirts because they know that t-shirts are really appealing to the people and they can even promote the brands in a better way. All you have to do is find a dealer that can print the logo of your brand on those t-shirts and then you can distribute or give away free t-shirts to your customers for some festival season or for their loyalty.
Caps are something that you should never miss out on because they are cheaper and effective. In fact they are cheaper than the t-shirts and you can be sure that they will soon make your products popular. You can design the cap the way you want it, you can even color it in the way you want and add the logo of your brand right in the center so that people around can take a look at it. This increases your brand visibility and people soon begin to realize that you are an upcoming company in the market.
In the recent years, people are more conscious about their health and therefore sporty water bottles are already making their mark across the globe. Hence, many business owners are thinking of giving away free water bottles that have sporty looks. Since water bottles have a larger area they can print the logo of their brands on it and color their bottles in different designs.
By: Jesse P Rees
Posted in Business | Tags: Brand Visibility, Caps, Different Companies, Free Shirts, Free T Shirts, Health, Loyalty, Promotional Company, Promotional Items, Promotional Marketing, Water Bottles | No Comments »
How to Work Out the Fair Market Value of a Charity Donation
Working out the fair market value of a car or boat that you would like to donate to charity can be a difficult process. The IRS clamped down on tax fraud several years ago and the rules for determining exactly what the ‘fair’ market value have also changed.
So, donating to a non-profit organization used to mean finding out the value of your vehicle from the Kelley Blue Book and the actual ‘condition’ of your vehicle was almost disregarded. This was good for the seller but cost the IRS over $640,000,000 in 2000 alone! Many cars were almost (or were!) unroadworthy, but this didn’t stop 3rd-party charity agents from helping people to claim the ‘fair’ market value in the form of tax deductions, take the car away for free and avoid scrap yard fees. Quite a good deal, I hear you say!
The IRS had to clamp down on the ‘fair market value.’ Some agents were taking 70% of the sale price in so-called ‘service fees.’ When the cards were eventually sold, the price differential was huge! The Kelley Blue Book requires that a car has to be running in order to even get into the ‘poor’ rating. The fair market value price was over-inflated compared to what a seller might have got by placing an ad in the newspaper.
Now, receipts are required if the donation is valued at over $250 and a statement is needed as to what the car sold for. If, after donation, the car is sold, it is now only possible to claim the same amount as the sale price to the NPO. If the car is actually used by the charity, then a donator can claim the real fair market value (the same as if you’d sold the car yourself). Confused yet?
If a vehicle is sold by a charity in the first two years after receiving it, then they must send a Form 8282 to you, informing you of what has happened to the car. But don’t panic, you won’t be required to change anything regarding your taxes.
Also, you should always take pictures of your vehicle so that you have some proof of its fair market value and if it has a value of over $5,000, then you will also need a written independent appraisal. The fair market value can also be claimed if the vehicle is to be fixed up and then sold.
So, give the situation some thought if you are thinking of donating a vehicle to a charity. It’s really not that difficult, but you do need to be aware of the main changes, instigated by the IRS, as outlined above.
By: Washington Stoker
Posted in Business | Tags: Actual Condition, Cards, Charity Donation, Clamp, Differential, Donation Car, Donator, Helping People, Irs, Kelley Blue Book, Many Cars, Non Profit Organization, Npo, Proof, Receipts, Running, Scrap Yard, Tax Deductions, Tax Fraud, Value Of A Car | No Comments »
Establishing the Value of Your Business
Some owners have a figure in mind of what their business is worth; often it’s inflated because of their emotional attachment. On the other hand, many owners undervalue their business because they do not understand the technicalities of the various valuation methodologies and which of these is most appropriate for their specific business type.
Experience has shown that there is also a large percentage of business owners who do not know what their business is worth, nor how to go about establishing its true market value. Link uses many of the established valuation methodologies, often using a range of different options in combination to establish the most accurate figure. This figure is then further scrutinised by comparing the theoretical value with current and historical sales information from the Link database. This ensures that the valuation appraisal accurately represents what a purchaser will pay in the current market.
Profitability and Risk
Most businesses are valued based on a combination of assets and the cash surpluses generated. The risk factor of the specific business is also taken into account. This is the degree of threat from existing or potential competitors, changes in technology or consumer trends and many other factors that may affect earnings or costs.
“Barriers to Entry” is another issue that is taken into account and involves evaluating the degree of difficulty or barriers a competitor may face should they decide to establish a similar business. For example, businesses which require minimal capital investment or technical knowledge are said to have a very low barrier to entry and consequently, may have a lower value.
Most businesses are valued on a “going concern basis” rather than the value of company shares. Purchasers are reluctant to buy company shares for a variety of reasons including the unknown possible future tax, credit or legal liabilities, or the danger of inheriting contingent liabilities based on historical trading. The price of the business is usually made up of three components:
1. Intangible assets.
The future earning potential of the business reflective of historical earnings potentially including intellectual property (IP), right to products or services, benefits of a lease, contracts, techniques and procedures as well as goodwill.
2. Tangible assets.
The fixtures, fittings, plant and equipment used by the business to generate its income. This component is normally calculated according to its depreciated book value.
3. Stock.
Stock purchased by the business for resale or manufacturing purposes. It is valued at the historical cost price. An allowance may be made for old or obsolete stock.
Valuation Methodologies
Generally, two or more of the following methods are used to appraise the value of a business:
1) Industry Ratios
2) Asset Based
3) Earnings Based
4) Market Based
The appraised value is then subjected to the “sanity test”. Some businesses are in a growth industry where their track record is well established and their projections solid. Other businesses may be in what is known as a sunset industry where projections are less optimistic. Many factors affect the true market value of a business, including business sector, economic conditions, business cycles, interest rates, labour availability and a whole host of other influences. Similarly, the value of trademarks, brands, intellectual property and goodwill is not always easy to quantify. Balancing all these factors with the book valuation of businesses establishes the true market value.
1. Industry Ratios
The value of the business is based on its sales record compared with industry averages. This method is often used for small businesses and franchises where there is an established track record within a specific industry. It may also use a formula of multiples of weekly sales or an average derived from sales of similar businesses.
2. Asset Based
In businesses where there is history of low earnings or perhaps even losses, the Asset Based approach is generally used. Using this method, the value of the collective assets (both tangible and intangible) will determine the value of the business. In many cases there will be an element of goodwill payable, even where a business is not trading profitably. Although the assets alone may be purchased on the open market, there is often value in purchasing assets as a going concern, which may include customer lists, relationships with suppliers, an assembled workforce, brand awareness and reputation, among others. Calculating intangible assets, including goodwill requires some subjective judgement coupled with experience and the use of market comparisons.
3. Earnings Based
Generally the earnings based approach is used for larger businesses and places emphasis on earnings rather than assets. There are various methods used when employing the Earnings Based approach to appraisals. Return on Investment (ROI) or capitalisation of earnings is common, as is the application of earnings multiples.
Earnings Based value is determined by considering:
A. The level of return that could be expected by investing in the business in question, taking particular account of the perceived level of risk and realistic costs of management.
B. The “industry average” multiplier on true earnings. This multiplier is market driven and varies according to perceived industry risk factors, perceived earnings sustainability and historical comparisons. The multiplier used most often in this approach is EBIT (Earnings before interest and tax) but others are frequently used and it is critical that you are comparing “apples with apples” when discussing multipliers.
C. The fair market value of the unencumbered tangible assets of the business e.g. plant, fixtures, fittings, equipment, stock and the tangible and intangible assets which may include intellectual property.
EXAMPLE OF ASSETS BASED METHOD
A dry-cleaning business has been breaking even and the owners would like to sell and move on. The business has tangible assets with a total book value of $135,000, $5,000 of stock (all saleable), no bad debts and will pay all creditors. The fair market value of the tangible assets has been assessed as $110,000 and intangible assets and goodwill at $15,000. Therefore the fair market value of this business is calculated as follows: $110,000 (tangible assets) %2B $15,000 (intangible assets and goodwill) %2B $5,000 (stock) = $130,000.
EXAMPLE OF ROI
Tom’s manufacturing company produced an adjusted net profit of $160,000 (EBPITD). The net assets (Valuation of plant and stock) for the business were $240,000 and a fair salary for Tom (owner) is $70,000. If someone was looking to invest in this business they could expect a 25% ROI, as this business offers a low to medium-risk investment opportunity.
To calculate the ROI value for Tom’s business:
Business profits (EBPITD) ………………………$160,000
Minus owner’s salary ………………………………$70,000
Profit ……………………………………………………$90,000
Return on Investment
Profit of …………………………………………………$90,000
Divided by desired return ………………………………..25%
Valuation appraisal ……………………………….. $360,000
4. Market Based
There will be certain instances where no amount of sound theory or application of complicated methodologies alone will suffice. It is not uncommon that a willing buyer and a willing seller will agree on a value that defies all traditional appraisal methodologies. In other cases the use of traditional appraisal approaches produce unrealistic values that have no bearing on market realities. It is important in any appraisal to overlay relevant market data and multiples achieved in similar businesses “in the real world”. Unfortunately the level of information available in Australasia is not as sophisticated as that available in other parts of the world.
How will taxes affect your pay out?
There are tax issues you may need to consider when selling your business. For instance, if you sell the plant and equipment (or company car) for more than the depreciated book value, you may have to pay back some of the tax you claimed when the items were depreciated (depreciation claw-back). Other tax liabilities may be incurred on the profit of land and buildings if they are included in the sale. It is vital that you fully understand your tax position when selling your business, and professional advice should be sought.
“Any desktop valuation involves a substantial amount of subjective judgment. The real test of the value of a business enterprise, like any asset, is what a buyer is prepared to pay.”
By: Aaron Toresen
Posted in Business | Tags: Accurate Figure, Barriers To Entry, Changes In Technology, Company Shares, Concern Basis, Consumer Trends, Contingent Liabilities, Current Market, Emotional Attachment, Going Concern, Legal Liabilities, Link Database, Market Profitability, Minimal Capital Investment, Risk Factor, Technicalities, Theoretical Value, True Market Value, Type Experience, Valuation Methodologies | No Comments »
Basic Definition of Business Ethics
One of the traits I’ve always prided myself with is having great ethics.
I believe ethics comes down to having a fundamental need for fairness, equality, humility and genuine concern for others.
In business, how do you have ethics when you need to be cut-throat?
Well I don’t believe you have to be cut-throat. Especially not online. I believe you can be ethical and be a highly successful business person.
So what’s a good definition of business ethics?
Well I think it is a combination of the following character traits in a business person:
Integrity – Sticking strictly to a moral code or ethical standards.
Honesty – To tell the truth, to never mislead by only disclosing the ‘attractive’ part of the truth and neglecting to disclose all information.
Sincerity – To be real, to never fake nice or interest to make sales.
Fairness – To do what’s right, to not take advantage and to be kind.
When it comes to the internet, I think there is the opportunity to have less than typical ethics because of the anonymity of it all. On the internet you can hide your face, your location and your true intentions easier than if you sat face to face with someone and boldly tried to cheat them. Well unless you’re just a pathological liar.
That’s why I think as internet marketers it’s really important that we define and state our ethics publicly, then make sure to show them in our actions.
How do you define ethics in your own business?
Is it ok to leave out some details? Is it ok to grab ideas from the competition? Is it ok to steal keywords, customers or affiliates from the competition? Where and how do you draw the lines and is it in line with your own personal ethics?
Some people are lead to believe that in order to have a successful business they have to use these sneaky tactics and moves. It’s a hunter versus prey mentality and it’s a total sham. You don’t have to hunt down your market and prey on them if that’s not your style. It’s definitely NOT the only option and you should know that.
There are many people making a full time living by providing real value in the lives of their prospects and customers. They do it because they love it and because their business is a labor of love. It’s not to say they don’t also have ambitious and achievable income goals – they do that too. Point is don’t think the only way to build a business is to be a shark out for blood.
Whatever you decide, make sure to align your personal ethics and business ethics. You’ll never truly love what you do if your internal ethics are compromised.
By: Angela Wills
Posted in Business | Tags: Anonymity, Business Person, Character Traits, Definition Of Business Ethics, Fairness, Fundamental Need, Genuine Concern, Humility, Internet Marketers, Mentality, Moral Code, Own Business, Pathological Liar, Personal Ethics, Sham, Sincerity, Sneaky Tactics, Successful Business, To Tell The Truth, True Intentions | No Comments »
What is Strategic Financial Management?
Strategic financial management is basically about the identification of the possible strategies capable of maximizing an organization’s market value. It involves the allocation of scarce capital resources among competing opportunities. It also encompasses the implementation and monitoring of the chosen strategy so as to achieve agreed objectives.
The key decisions falling within the scope of financial strategy include the following:
1. Financial decisions – this deals with the mode of financing or mix of equity capital and debt capital. If it is possible to alter the total value of the company by alteration in the capital structure of the company, then an optimal financial mix would exist – where the market value of the company is maximized.
2. Investment decision – this involves the profitable utilization of firm’s funds especially in long-term projects (capital projects). Because the future benefits associated with such projects are not known with certainty, investment decisions necessarily involve risk. The projects are therefore evaluated in relation to their expected return and risk. For these are the factors that ultimately determine the market value of the company. To maximize the market value of the company, the financial manager will be interested in those projects with maximum returns and minimum risk. An understanding of cost of capital, capital structure and portfolio theory is a prerequisite here.
3. Dividend decision – dividend decision determines the division of earnings between payments to shareholders and reinvestment in the company. Retained earnings are one of the most significant sources of funds for financing corporate growth, dividends constitute the cash flows that accrue to shareholders. Although both growth and dividends are desirable, these goals are in conflict with each other. A higher dividend rate means rate means less retained earnings and consequently slower rate of growth in future earnings and share prices. The finance manager must provide reasonable answer to this conflict.
It should be noted that the theory of corporate finance is based on the assumption that the objective of management is to maximize the market value of the company. More specifically, it is settled in finance that the main objective of a company should be to maximize wealth of its ordinary shareholders.
By: Obafemi Toriola
Posted in Business | Tags: Capital Projects, Capital Resources, Capital Structure, Cash Flows, Debt Capital, Dividend Rate, Equity Capital, Financial Decisions, Financial Management, Financial Strategy, Investment Decision, Investment Decisions, Maximum Returns, Minimum Risk, Portfolio Theory, S Market, Scarce Capital, Share Prices, Sources Of Funds, Term Projects | No Comments »
Purchasing – How You Should Market Your Purchasing Skills to Your Peers
In many organisations, the skills of the purchasing department are not always recognised. They are perceived as the team that administers a contract letting process or provides other procurement related administrative services. This means that many of the tasks that determine the ultimate cost of the things that you buy (such as setting the specification or negotiating with suppliers) are carried out by the users or budget holders who often have little commercial experience. The result is that your organisation fails to get the best value from the money it spends with suppliers. If you are in this position, what you need to do is to market your services to your organisational peers outside of the purchasing department.
The first step is to understand exactly what marketing means so that you can use it effectively. One definition of marketing is “the management process responsible for identifying, anticipating and satisfying customer requirements profitably”. This means that to market your purchasing skills to the rest of your organisation you need a process that helps other departments to obtain the things they need from supply markets at a cost that is lower than if they did it themselves.
So with that in mind, here are some tips for how you can market your purchasing skills.
o The first step is to identify your customers. One way to do this is to analyse your spend data and find out who is currently buying things outside of your purchasing process. This can be as simple as running a report of spend by cost centre that also shows you the suppliers used and then compare this with your contracts register. If people are buying things without a contract then it is a sure sign that they are not using your services.
o Once you know who your potential “customers” are you need to put together a plan for how you can help them. For example, you could compare the price they paid with a contract price that you already have or with an external benchmark. This will show how much you could have saved them. Alternatively, you can explain how your processes for working with suppliers could have helped them to develop a better specification.
o You also need to understand how to anticipate what their needs might be. You can often get this by looking at their annual budget or service plans to see if you can identify any requirements (either revenue or capital) that they may have from third parties. You can them put together a high level analysis of the supply market showing them what levers you can help to pull to drive out costs and increase quality or service.
o You then need to put all of this together into a presentation. Depending on the audience this can be an informal conversation or a more formal presentation. In either case, what you need to do is build your case for involvement in the spending of their budgets. A useful framework for this is to spell out the features of what you can do for them (that is the activities and what you will do), the benefits for them in those features and above all the “reason to believe” – in other words, what evidence can you present to show them that you are capable of delivering your promises. Remember that at all times they will be tuning in to their favourite radio station WII FM (what is in it for me!).
o You need to put all of this into a process so that identifying and anticipating others’ needs and turning it into practical solutions for how purchasing can help becomes an automatic thing.
By: Stephen C Carter
Fair Value Accounting – The Vexed Question
Welcome to the first edition of the Genesis Analytics Bank Board and Corporate Governance Brief for the Middle East. In these monthly briefs, we will be exploring some of the key issues in banking and corporate governance today, and will be examining what they mean for banks and financial institutions operating in the region.
We begin by taking a look at the role that fair value accounting had to play in the global financial crisis, and ask whether calls for a re-evaluation of how it is applied are justified.
In the March edition of the Harvard Business Review, the Chair of MFS Investment Management, Robert C. Pozen, asked what is, for many, a vexed question: “Is it fair to blame fair value accounting for the global financial crisis?”. The answer is far from simple, but Pozen’sexploration of the issue is illuminating.
Mark-to-market or fair value accounting has received a bad rap, and some commentators -including Steve Forbes, the Chairman of Forbes Media -have laid the blame for the entire financial crisis at its door. Pozen, however, questions whether this practice, which pegs the value of assets to their real value in the open market, can really be blamed for the shockwave that pulsed through the world financial markets eighteen months ago.
Some bankers have claimed it was fair value accounting that precipitated the global crisis after the credit freeze of 2008 drove down the value of key assets in their portfolios to record lows. They have argued that fair value accounting rules affected the value of these assets so badly that, although the majority of mortgages, corporate bonds and structured debts were still performing, many banks found themselves facing insolvency.
Persuaded by these arguments, politicians in both the US and Europe have called for a suspension of fair value rules in favor of historical cost accounting, which allows for assets to be valued at their original or purchase price. Fair value accounting, however, has its defenders, amongst them Lisa Kroonce, an accounting professor at the University of Texas.
“This is simply a case of blaming the messenger,” she said in an article in Texas magazine recently. “Fair value accounting is not the cause of the current crisis. Rather it communicated the effects of such bad decisions as granting subprime loans and writing credit default swaps… The alternative, keeping those loans on the books at their original amounts is tantamount to ignoring reality.” Shareholder groups and the Financial Accounting Standards Board (FASB) back this position, claiming that it is more important than ever to know the real market value of assets in bank portfolios.
So is this a black and white issue, or is there more to it than that?
Genesis Analytics would argue it is not only accounting practices that matter in times of crisis, but also the depth with which banking boards understand both the rules and the issues they reflect. Obviously, it is in no-one’s best interests for banks to go bankrupt because of short-term fluctuations in value. By the same token, it is in no-one’s best interests to hide losses from investors, or to delay the cleanup of toxic assets if and when necessary.
It has therefore become clear that, in order to take the legitimate needs of both banks and investors into account, a new multidimensional approach to financial reporting needs to be adopted, one which takes both historic value and mark-to-market value into account.
Before this can be done, though, it is important that some misconceptions about accounting rules and methods be cleared up.
For one thing, it is incorrect to assume that historical cost accounting has no connection to current market value. Granted, under historical accounting rules, most assets are carried at their purchase price or original value, with minor adjustments for depreciation over their lifetime (as in the case of buildings) or for appreciation until maturity (as in the case of bonds bought at a discount to par). However, even under these rules, current market values are factored into financial statements, and listed companies and financial institutions have to report on whether any of their assets have been permanently impaired. So, even if assets are being carried at their original value, institutions have no option other than to report a permanent decrease in their value if this occurs, although they are able to do this in a more measured way than fair value accounting rules allow for.
It is also incorrect to assume that most of the assets held by financial institutions are marked to market. In fact, according to an SEC study conducted in 2008, only around 30% of bank assets are treated in this way, and the rest are accounted for at the historical cost. This is because, under fair value rules, management is required to divide the institution’s assets into three categories: those that are held, those that are traded and those that are for sale.
So, if management intends and has the ability to hold certain assets to maturity, they are carried on the books at historical cost, and are only written down if permanently impaired. In contrast, all traded assets are marked to market on a quarterly basis, and any decrease in the fair market value of a bank’s traded assets have to be reported on that basis.
Finally, there would be no question about fair value accounting if all assets were highly liquid and easy to value at direct market prices, but this is obviously not the case. As markets are not always liquid, fair accounting rules do, however, allow for two additional levels of evaluation which permit bank executives to value assets based on observable market inputs or on original cost.
So, when all the dust has settled, it becomes clear that historic cost accounting and fair value accounting are not as far apart as they may seem. The art of managing a bank or financial institution through a crisis clearly lies in something greater than accounting rules. At times like these, it falls to bank boards to equip themselves with the knowledge and information required to make in-depth and informed decisions. In a dramatically changed financial services environment, only boards that have this kind of in-depth understanding are able to keep their institutions on a steady course in even the most challenging of times.
KEY POINTS FOR BOARD MEMBERS:
-Fair value accounting is a fundamental governance issue that has a direct impact on bank performance
-It is important to understand the movement of assets between different categories, and the bank’s auditors should be asked to give details of any such movements should they occur
-It is equally important understand the assumptions on which the valuation of assets and their classification into different categories are based
-Major changes in classification should be carefully monitored
-It is vital to understand the fair value accounting rules that apply within the jurisdiction that the bank operates
Genesis Analytics recommends that bank boards avail themselves of facilitated briefing and strategy sessions on a regular basis in order to ensure they are properly equipped to deal with a constantly-changing financial services environment. Genesis Analytics is an advisory firm that works with the boards of financial services institutions in order to improve their insight into and understanding of the institutions they govern, as well as the context in which they operate.
By: Richard Ketley