Business in Progress

Recently a leading think-tank, the Ernst & Young Item Club, said that the economic outlook for Britain is like a "horror movie".

In my opinion that is a contrived exaggeration designed to catch the attention of the media.

One wonders what metaphor they would possibly have substituted if they had been commenting in 1926. However, there are so many doom merchants plying their trade at the moment that trying to go one better might be expected.

So, just how bad is the economic outlook as seen by the Item Club? What constitutes a “horror movie” these days?

Growth in UK GDP during 2007 was 3.1%. The Item Club expects growth of 1.5% in 2008 and growth of 1.0% in 2009 before it returns to 2.5% in 2010.

Growth????

Oh, yes! Ernst & Young are not forecasting a recession … far from it. They are expecting that the UK economy will continue to grow.

This is about as close to a horror movie as Willy Wonka and the Chocolate Factory.

Even if things turn out worse than Ernst & Young’s choice of prose, professional firms need to get a sense of proportion. In the US Great Depression 1930-33 the reduction in the level of GDP from peak to trough was a fall of some 30 per cent.

That means that some 70% of output was maintained, although the exact figures will have varied from sector to sector and firm to firm. Nevertheless the point is well made that business continued to happen. Some people even did remarkably well out of it.

Therefore, what you can be sure of is that, no matter how poor the economy gets, substantial amounts of business will still get done.

The only question you need to answer is whether you will be among those doing that business.

There is a recognised 3-step process that will help you towards a positive answer:

1. Raise your standards. Increase the levels of service that you provide and the attention that clients receive. Satisfactory is not good enough, either to win new business, or retain existing accounts.

2. Change your beliefs. Who your prospects are, where they can be found, what they want and your capacity to meet those expectations all need rewriting. The world has moved on; you need to keep pace or you will be left behind.

3. Revise your strategies. Whatever game plan you have been following is now familiar to all your staff and most of your competitors. It’s predictable. “A skilled commander seeks victory from the situation and does not demand it of his subordinates” ~ Sun Tzu.

For the outlook to be perceived as bad is nothing new.

Recently, Sam meets his friend Joe in the Arndale Centre and greeted him warmly.

"Hi Joe, I haven’t seen you for some months. So how is the company doing that you set up with Maurice last year?"

"Well,” said Joe, “As I told you then, I put in all the money and Maurice put in all his business experience. But things have changed a bit since then."

"What do you mean?" Sam asks.

"Now Maurice has all the money and I have all the business experience."

Clinging to the Wreckage

UBS, Switzerland's largest banking group, has just written off $37bn (£18.7bn) of its sub-prime investments.

Following an internal investigation demanded by the Swiss Federal Banking Commission, the Swiss version of our own dear FSA, it admitted a series of mistakes including inadequate supervision, poor risk management and a failure to react quickly enough when the sub-prime market started crumbling.

UBS was so focused on racking up ever larger profits that it “forgot” every silver lining has a cloud.

This is its first full-year loss (Sfr4.38bn for 2007) since its came into being 10 years ago following the merger of Swiss Banking Corporation and Union Bank of Switzerland. Planned job cuts are rumoured to run to more than 3,000 people.

As one might expect of the Swiss, those in charge have shouldered their full share of the responsibility and suffered the inevitable consequences. The Chief Executive, Peter Wuffli, was ousted in July last year, followed by the CFO, Clive Standish and the Head of Investment Banking Huw Jenkins. This month it was announced that the Chairman, Marcel Ospel, would not seek re-election.

Meanwhile, here in the UK, RBS came up with a further £5.9bn of write-offs on bad debts yesterday having already declared a £1.7bn write-down of sub-prime investments in December. However, you would search in vain for any admissions of abject personal failure by top management, let alone a principled resignation. In any industrial company the chairman and chief executive would both have been fired and forgotten by now. Not so with RBS.

Apparently RBS's has two excuses: (1) things have changed, and (2) it didn't foresee quite how bad things would become. Well, isn’t that what leaders are paid to do? Doesn’t leadership imply vision – the ability to see and foresee, rather than stumbling over the truth, picking themselves up and hurrying off as if nothing had happened (Churchill). And if they fail to uphold their end of the contract should that contract not be properly terminated?

According to Sir Tom McKillop, the RBS chairman, the board is unanimous: the current team is the one to take the bank forward. On what logical basis should that be the case? Those that have engineered dramatic expansion are rarely adept at managing either a holding operation, or retrenchment. Those call for very different skills. Endangering the ship when it’s in stormy seas, based solely on your capacity in calm waters, constitutes reckless conduct in anybody’s book.

Marianne Jennings, Professor of Legal & Ethical Studies at Arizona State University has identified the belief by management that they are so brilliant and innovative that the mundane rules of accounting, corporate governance and even basic economics do not apply to them as one of the seven signs of ethical collapse. RBS fits the bill.

Of the five leadership traits identified by Kouzes and Posner’s research that was done for the book ‘The Leadership Challenge’ namely:

~ Honesty
~ Forward-Looking
~ Competency
~ Inspirational
~ Intelligence

RBS seems to fall short on the first three.

If the Swiss banking fraternity have the principled leadership qualities needed to do the right thing then those privileged individuals on this side of the Channel should exhibit the same qualities.

Time to Get Real

In a recent post Damian Wild recalls Sir John Harvey-Jones’ optimistic expectation that “at the present rate of progress, everyone will know the financial position of the company at every level in real time”. However, Sir John was sufficiently realistic to note, “FDs could be the key gatekeepers making that happen or they could be the abominable snowman preventing that from happening.”

Unfortunately, casting around in the snows of corporate reporting for recent signs of Bigfoot there is plenty of evidence that FDs, and the accounting profession in general, are leading the corporate world deeper and deeper into the trackless wastelands. Financial reporting has now become so esoteric that fewer and fewer people understand the figures that are put in front of them. We are light years away from the stewards of the business (directors) accounting to owners (shareholders) for their conduct and we seems to be accelerating.

City figures have asked questions about the reliability and relevance of fair value accounting when mark-to-market valuations are based on an insignificant number of related market trades. Many have been even more sceptical about mark-to-model assumptions used to value illiquid assets. If Sir John’s Yeti is a mythical creature of folklore and legend, perhaps it is only fitting that FDs are now accounting in make-believe money.

The Association of British Insurers has claimed recently that investors feel audit committees don’t know enough about what is going on. According to Peter Montagnon, director of investment affairs, “This relates to the committees’ knowledge and also to the accounting standards and what has to be reported.” Where does this leave the average shareholder? The ceaseless change, standardisation and internationalisation of accounting rules when combined with the increasing complexity of financial instruments has succeed in generating an impenetrable fog around the conduct and condition of our major institutions.

Grant Thornton claims that “audit committees, are having to place increasing reliance on financial directors and auditors to explain the IFRS accounts and to obtain appropriate assurance” as they attempt to find their way through the traps and tripwires set by standards on financial reporting. If this level of support is required by highly paid and experienced businessmen at the head of our major quoted companies, how is the man in the street expected to cope? In trying to understand the labyrinthine logic of their own conduct do our public companies now face the centipede’s dilemma?

Last week’s Accountancy Age editorial wonders whether the current confusion and uncertainty being experienced by audit committees would be most easily resolved by regulation, such that those that serve on them meet some minimum level of financial acumen. This proposal only serves to distance the shareholders even further from the core issues. If only those who are specially trained can hope to understand what is happening where does that leave the underlying fundamental associated with accounting – giving a convincing explanation of what is going on?

Sir David Tweedie, head of the International Accounting Standards Board has suggested a form of parallel balance sheet on which entities such as SIVs could be explained in greater detail. Sir David must accept a large measure of blame for the sorry mess that corporate reporting now finds itself in. Floating the idea that companies ought to keep two sets of books would appear to be the final scene in an increasingly farcical drama.

Sir David claims, “What we’re trying to do is simplify the accounting”. Wonderful! Then let’s do just that. Let us make everything as simple as possible, but not simpler and introduce what I shall dub “The Alf Garnett Test”:

1. Take your next financial instrument, accounting standard or set of Statutory Accounts into a randomly selected local boozer (wine bars, tapis parlours and cocktail lounges excluded) .
2. Approach the nearest person at the bar.
3. Ask him or her to explain what they understand your document to mean.
4. If they can give a cogent explanation in ten minutes or less, then you may publish.
5. If not, scrape it, buy a round of drinks and get back to reality.