A Guardian headline in recent days says “Tesla shares soar 40% after analyst says firm’s value could hit $1.3tn“. Similar headlines could be seen in other newspapers. So, the market values Tesla at $1.3 trillion, yet their 2018 10K shows assets valued at around $30 billion, and accumulated losses of $5.3 billion. So, why are these values so different? This is something students of mine often ask. I’ll try to give a simple answer.
The market value is based on expectations for the future, and these drive up the share price – some media sources though suggest the price is being driven by short sellers trying to buy shares to cover losses they may be making as they bet against Tesla shares rising in price. Accounting values are in general based on historic cost – what was paid for something in the past. Also, for example, accounting does not include items which do not have a historic cost – such as the Tesla brand name. Thus, accounting statements do not reflect future plans or values in general. If another business were to buy Tesla, then its actual (market) values would be captured by accounting of course – brand value, goodwill and such things not captured previously. At this purchase point, there is a historic cost.
Yes, there are some whiskies produced in Taiwan, and they are winning some awards and grabbing attention in the whisky world. I wrote an article on The Conversation recently which looks at how Taiwanese whisky producers have some costs and cashflow advantages over other producers. You can read it here. Sláinte
As you may know, there are public and private companies. Public companies can sell shares to members of the public, normally through a broker or exchange, private companies cannot. Both must prepare accounts though, and must also file certain accounting information which in turn becomes available to the public. So what accounting data can Joe Blogs get? The answer is it depends, but I will give you a good idea on this post.
In most European countries there is a central register of all companies – as far as I am aware the US does not have such a register, and the SEC focuses on public companies only. In Ireland and the UK, a small fee via an online portal gets me at least a balance sheet of a company – an abridged version for small companies – and an annual return which shows the directors and shareholders and their details (such as address). To give another example, in Germany I can download a free app called the Bundesanzeiger and search for details of any company – again for smaller companies I can get a summarised balance sheet.
For larger companies, including public a lot more information is available of course. But even with a balance sheet, or more of the company is medium or large, I can obtain quite a good picture of the financial position of a private company, and quite detailed information of directors and shareholders. Such information can be very useful to prospective investors, suppliers, customers and even employees. Why not search for a private company you know and see what you can find.
Ok, so I guess I will start with a caveat – I am not a fan of Elon Musk. He may be a great guy, I have never met him, but as an accountant, I see him as one of those entrepreneurs who may have good business ideas and models but they fail to turn them into profit. Tesla is a good example, and of course, I may eat my words in the future, but the company has yet to make any profitable product in a consistent manner – and they are on the third model of their car!
Looking at the Tesla 10K (which includes the financial statements) at the end of 2017, the accumulated losses are just under $5 billion. Okay, if we look at the balance sheet, the assets exceed liabilities, but some of the assets probably could lose value, or be over-valued, which would wipe any net assets. And okay, I get it that Tesla is breaking a mould, but they are not the only ones trying to make better cars. But, the company is 15 years old this year and still has accumulated losses; and the media reports production problems with the latest model still. And, it’s most recent quarter losses are about $700 million. So, let me ask this, would you invest in a company that cannot make a profit after 15 years? As an accountant, my verdict is no way!
In my daily work as an accounting academic, income across many papers and articles which explore the broader role of accounting in society and out daily lives. Lisa Jack from the University of Portsmouth writes about the role of accounting in the food supply chain. This is a very interesting area, as information on costs and margins is crucial in the food sector. She has just published an article on the recent contamination of eggs in some
European countries – you can read it here. It gives a good overview of how accounting is entwined in this and other food issues, and how it could help.
As you may know, we can use ratio analysis of financial statements to form a view of how a business is doing. One area worth looking at is liquidity and solvency, which we can for example assess using the current ratio or other working capital ratios.
I came across a great example of a “technically” insolvent organisation recently – none less than the professional body I am a member of, CIMA. Below is an extract from their financial statements of 2016 , but first let me briefly explain what insolvency means. Solvency means a business can pay its debts as they fall due, and technically, if current liabilities exceed current assets, a business is insolvent.
If we take a look at the current assets, the total value of current assets is £18,760,000, whereas current liabilities equals £22,564,000. Thus, technically CIMA is insolvent. What makes this example even more interesting is that if we look at the current liabilities, about £13m is deferred income, the subs in advance. These are already included within the cash balance, or the cash has been spent already, so they are not really a liability per se. However, if CIMA were to close tomorrow, it would have to repay these subs to members. So the cash in the bank more or less could cover this, but then if all receivables were paid they would not cover the payables.
Have a look at the full accounts at the link above if you want to see more.
IAG, or the International Airlines Group, is the the parent of Aer Lingus, British Airways and Iberia. In my university, we were lucky enough to have their CEO, Willie Walsh, speak to us before Christmas.
Some things he mentioned are relevant to this blog, and of course interesting. One thing Mr Walsh noted was how only in recent years has the airline sector actually made a return on capital. This must be attributable in some way to a focus on cost by the sector in recent years. The chart below from IATA shows what I mean. As you can see, the cost of capital was higher than the return until 2014.
As my last post indicated, a focus on cost and efficiency has been a feature of the airline sector in recent years. To give another example, Mr Walsh cited an example of using two larger aircraft on a route without a loss in passenger capacity. So fuel, crew and capital cost all decrease in such a scenario. In addition, it freed up a slot at London’s Heathrow airport, which can then be used to generate more revenues.
Probably my favourite (spectator) sport is motor cycle road-racing. There aren’t too many places it still happens – doing 180mph on public roads is not for everyone – but thankfully it still happens here in Ireland, the Isle of Man (IOM) and a few other places.
The IOM TT is probably the pinnacle of road-racing – it’s two weeks of fund each June. imagine my delight when I read an article featuring news on the 2016 TT and creative accounting! The article notes the number of TT visitors for 2016 to be similar to 2015 – based on data from the IOM government. The article also suggested a revenue of £738 per visitor for the economy, based on this same data. In the comments beneath the article, the fun starts.
One comment notes:
“This year’s TT races in June brought a £4.1 million benefit to the island’s exchequer, according to government figures just released.” OK, so that is the claimed revenue, now let’s see the total costs. And by total, I mean the total cost to the island not just the cost of TT preparations. How much for a fatality or serious injury involving medevac? How much for the road closures and effects on businesses as well as the public? These are real costs and the list goes on.
I note the total expenditure of £738 pp is not broken down into for example travel costs and monies spent on island. Therefore that figure is meaningless If the figures of £31.3M, £22.5M and £4.1M are based on the £738pp they are also meaningless. Creative accounting it is for sure. In addition, if the government can come up with a figure for the benefit to the island they must be in possession of all costs, such as DOI, medical, policing, helicopters etc. So why do they never produce such figures?
These two sharp commentators highlight many things -the subjective major of accounting, where costs and revenues are attributed, and what are the relevant costs, for example. I’ll be using this example in my teaching at some future point.
In recent years many operations – both business and public sector – have been closed or reduced in capacity to save costs. Closing an operation is one of the topics I often teach too. When I teach, the basic message is to focus on the fixed costs, and how much can be reduced or eliminated. Of course, some labour costs are increasingly seen as fixed – and this may be a more certain feature in the public sector.There may also be some hidden or unforeseen costs, which are often not included in the analysis. Let me give you two recent examples, both of which are from the public sector.
In Ireland, the government closed down 139 Garda (police) stations due to economic woes. Most of these closures were in rural areas. The total annual cost saving is estimated at just over €500,000 – see here. This is likely due to the fact that only the only savings were operating costs of the stations e.g. light and heat were the only real costs saved. Police staff and equipment simply moved to another station – where costs may have been incurred to accommodate them. There is a big hidden cost though, which is increased rural crime. While there was probably no money value on this cost in any cost estimates prepared, I’d be quite sure it is higher than closing stations. Recently, the decision to close has been reversed.
A second example comes from Lambeth council in London who closed two libraries – see here . According to a report in the Guardian, the daily security cost is higher than the cost of keeping the libraries open. There seems to have been some protests against the closure of one library in particular, which drove up the costs. This unforeseen cost, if included in the closure decision might have changed things.
My colleague Michael Farrell has written a nice post explaining the dodgy accounting transactions at Anglo Irish Bank – the bank that was a big part of the Irish financial crisis in recent years.
You have probably heard about the amount of fruit and vegetables wasted in the food supply chain. This waste “occurs” for three main reasons. First, in less developed countries, poor transport and storage can result in waste. This also happens in larger developed countries, where distances mean fruit/veg cannot survive the trip. Second, the exacting standards imposed by retailers as to the size and shape of fresh fruit and vegetables causes growers to simply dump large quantities each year. Third, end consumers throw away perfectly good food.
Personally, I grow some fruit in a small suburban garden. We never but jam, as I make enough for the household for the whole year. We have 2-3 months worth of pears and apples, and some years the “leftover” fruit become wine – blackcurrant wine is quite nice. So, from a small say 10m2 plot, I can do all this and have zero waste. On a commercial scale, things are different. The waste is immorally high, primarily due to the exacting standards of retailers. I can tell you that the apples and pears I grow may be all shapes and sizes, but they taste so much better than anything I can buy in the supermarket – and my neighbours all agree.
To give a snapshot of how much perfectly good fruit and vegetables we waste each year as a race, National Geographic (March 2016) provides some stark numbers. In total, 53% of fruit and vegetables never makes it to the market – 20% is lost at the farm due mainly to exacting standards, 19% is uneaten and discarded at home, 3% lost in transit/storage, 2% lost in processing (canning/baking) and 9% discarded by wholesales and retailers. Add to this the resources used to harvest and prepare what is wasted – 70 times the oil lost in Deep Water Horizon and enough water to fill the Volga, and that’s just one year in the US alone. To add another number, the annual total food waste (all foods) could feed 2 billion people.
From these stark numbers, what can (management) accountants do? Recently, some documentaries on British TV featured vegetable growers saying the loose perhaps £100,000 per month worth of vegetables – assuming it could be sold at market price. Nowhere is this accounted for, not in their accounts, in supermarket accounts, in our national accounts (GDP). What if these accounts included the cost of waste? I’m sure if they did, we would all stand up and take notice.
The above headline appeared in an article in The Times recently. There is something fundamentally incorrect in what it says, which I detail below. Let me say first that I am bashing the article author or the paper, as most papers do such things when covering firm performance.
So what is wrong with above statement? Simply, it is the application of the accruals concept in accounting. Under this concept, revenues and expenses are matched, and when cash is received/paid is not relevant – at least in the calculation of profit.
Here is a simple example. Let’s assume a business sells goods for $1,000 cash but has not paid the supplier. The goods cost $600. The profit on this is $400. If the supplier is never paid, or is paid in 10 days, the profit will not change.
While the article is incorrect in terms of the title, it’s message is solid – that you can benefit by not paying people. In the simple example above, the business has $1000 in the bank.
To this audience I ask two questions
- do you understand short-term versus long-term? If you do, which applies to your decision-making?
- are there any trained management accountants working in banks? I know there are, so read below if you are one of them.
While driving back from Cork recently, I heard a decent sounding lady with six kids telling a story about how a bank was repossessing the house her family rented – it was the Joe Duffy show on RTE Radio 1. The landlord could not afford the loan repayments it seemed and the bank wanted to sell the house. The family worked, and had sufficient income to pay rent into the future. The husband worked in a state-job, so as secure as you could get. She tried to communicate with the bank, but got a “computer says no” type response from the bank. To me, and I am just a management accountant, not a banking expert I could not see the logic in selling the house. Something instinctively told me taking a longer term view is a better choice.
Based on the information she gave during the radio show, when I reach my home I opened an Excel sheet. I checked the rent the lady might be paying – from daft.ie – and then I started to use the simple PMT function in Excel. I made assumptions that the landlord stopped paying the bank loan based on the original house value in 2010; that the bank would allow the lady to take over the mortgage at the present market value of the house and at the present interest rate. I did not adjust for the time value of money. You can see all my workings at this link:
The total time to do the above calculations was about 20 mins. I admit, Excel is not perfect, and I do not adjust for the time value of money – I don’t think it will make things vastly different. To keep it short, if the bank allowed the lady to take over the house as described above, they would gain to the tune of just under €86,000. Based on my simple calculations, the lady could afford to pay this. So, taking a longer term view, the bank (and by definition it’s shareholders) would benefit compared to ditching the house now.
Some further points on costs. I ignore legal costs, as the bank would have to suffer legal costs on either a sale or re-mortgage. But there is a bigger elephant in the room on costs. The lady would be homeless, someone would have to pay this cost – directly or indirectly, and ultimately the state. If I extrapolate the social costs, what is the family (who seemed decent) became homeless, the family fabric was disturbed and the kids turn to crime in the future. How much would this cost in money terms ?
So back to my questions. The scenario I describe above is being repeat all across Ireland. As a person, and an accountant this annoys me. The view of banks seems to be short-term only, driven by profit only. Now don’t get me wrong, profit is good, it creates jobs and investment. But we must not view profit from a short-term perspective. So, to the bankers, give me an answer to the above questions. If you are a trained management accountant, you should be thinking long-term, and if not, don’t think you cannot fail by taking short-term views. As you know banks have failed, as the leading image here should remind you.