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On Target Feb - Mar 08
Can Corporate Collapse be Predicted?
The collapse of HIH in 2001 cost the Australian economy an estimated 5.3 billion dollars. To put this in some perspective, in the same year an estimated 300,000 smoking-related hospitalisations cost the Australian economy $682 million. Thus, the costs incurred as a result of the collapse of HIH could have funded over 2,300,000 smoking-related hospitalisations, which is equivalent to about 12% of Australia's population.
Therefore, it seems worthwhile to invest resources in research that could assist in predicting collapses early enough to allow for corrective measures to be taken. Although putting forward a convincing argument for the necessity of coming up with a way to predict collapses may not be such a difficult task, coming up with a successful method that generates accurate predictions is a different matter altogether.
One approach adopted by Dr Gus Hossari, a Senior Lecturer at the Deakin Business School, involves the analysis of key items in financial statements. Listed companies like HIH make their financial statements available to the general public. Therefore, the information required to carry out the analysis can be easily obtained. More specifically, Dr Hossari's analysis relies on four items in the financial statements; they are Cash Flow, Net Income, Total Assets and Total Liabilities. However, the four items do not contribute equally to predicting collapse. For instance, Net Income and Total Assets contribute most, whereas Cash Flow and Total Liabilities contribute least. For this reason, each item is given a weight that reflects how important it is in predicting collapse: the more important the item is, the higher its weight.
At the termination of the analytic process, a probability of collapse is calculated based on the values of each of the four financial statement items and their corresponding weights. The probability is basically an indication of how likely collapse is. The probability of collapse could go from as low as 0%, which indicates no likelihood of collapse, to as high as 100%, which indicates that collapse is imminent and likely to occur possibly within a year. Therefore, the closer the probability is to 100%, the more likely collapse is.
Moreover, probabilities are adjusted for any persistent industry effects. The idea behind this is that probabilities might not be directly comparable between different industry sectors. The analytic method that Dr Hossari applies automatically takes industry effects into consideration, when such effects exist.
In addition, it is necessary to calculate probabilities of collapse over a number of consecutive years in order to observe a trend. For example, a probability that increases from one year to another is a sign of increasing financial trouble. On the other hand, a probability that decreases from one year to another indicates improvement in financial standing.
Referring to HIH again, five probabilities of collapse can be calculated. The first probability is based on the latest financial statements prior to the collapse of HIH in 2001; the second probability is based on financial statements in the preceding year; the third probability is based on financial statements two years prior to that, and so on up to four years prior. The probabilities that Dr Hossari generated ranged from approximately 79% to 81%. That is, there was on average about an 80% chance that HIH would collapse. Such a high probability, which presided for almost four years prior to the collapse of HIH, is an indication that the company's financials were persistently shaky and that the company was heading towards financial disaster.
Thus, if applied during the four years prior to 2001, the analytic process that Dr Hossari relies upon would have signalled financial distress for HIH; which suggests that the same process could be applied to signal potential corporate collapses in the near future.
So, can corporate collapse be predicted? The answer is dependent on the suitability of the method used. Considering that Dr Hossari's approach has been developed for Australian companies, not only would corporate watchdogs find his method to be a useful tool in assessing the financial standing of corporate Australia; Chief Executive Officers interested in keeping a finger on the financial pulse of their Australian organizations would likewise find the analytic approach to be of value.
Thus, when used judiciously, Dr Hossari's method becomes a powerful tool that pinpoints areas of financial trouble; and where corrective measures can be taken, it could potentially turnaround an organisation that otherwise was on the road to financial disaster.
Carbon Emission and Sequestration Accounting
Before carbon emissions trading can be considered, quantification in terms of carbon sourced or sequested by undertaking the activities that make up the supply chain must first be undertaken. The mechanism for calculating the quantum of CO2 either emitted by a source or sequestered in a biomass sink it will be referred to in this paper as 'carbon emission and sequestration (CES) accounting'. The CES accounting mechanism must be sufficiently robust that the carbon trading market has confidence that the amount of carbon sequestered can be both measured and considered to be equivalent in its impact on global warming potential to the CO2 released to the atmosphere from activities producing greenhouse gases.
As can be appreciated, the detailed requirements for a CES accounting system are continually being developed by organisations such as the Intergovernmental Panel on Climate Change (IPCC, 2007) under the United Nations Framework Convention on Climate Change (UNFCCC). Any CES accounting standard developed by a country or NGO will need to be consistent with the IPCC principles before carbon credits generated from carbon sinks can be used in an emissions trading regime under the Kyoto Protocol.
Other CES measurement and reporting approaches recognised in a global context are the Global Reporting Initiative (GRI, 2006); the United Nations Conference on Trade and Development's (UNCTAD) Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (UNCTAD 2006) and the World Resources Institute and the World Business Council for Sustainable Development (2007) with its Greenhouse Gas Protocol (GHG Protocol).
With respect to the CO2 emissions costing component of the wider environmental costing components, the US EPA has created a Waste Reduction Model (WARM) as a web-based calculator to help organisations calculate greenhouse gas emissions (CO2 and BTU) reductions from different waste management practices (e.g. source reduction, recycling, combustion, composting, and landfilling).The results are given as one metric tonne of CO2 either removed from the atmosphere or saved from being emitted. The challenge for the cost accountant is to 'convert' this to a product or service related cost.
The US EPA has also created a Recycled Content (ReCon) Tool as a web-based calculator (see http://yosemite.epa.gov/oar/globalwarming.nsf/content/ActionsWasteToolsReconOnline.html) helps companies and individuals estimate greenhouse gas emissions and energy impacts from purchasing and/or manufacturing materials with varying degrees of post-consumer recycled content. GHG Protocol is also available as a web-based calculator.
There are also many organisations, governmental and private, that provide web-based calculators to determine the reduction in specific air emissions (nitrogen oxides, sulphur dioxides, CO2, volatile organic compounds, particulates and mercury) resulting from energy conservation initiatives in business organisations. Information can be entered for both electricity reduction (in kilowatt hours) and natural gas reduction (in therms). There are other calculators that allow one to determine greenhouse gas emissions resulting from the use of cars and airlines for travel.
Some of these web-based calculators have a detailed description of the methodology and metrics used in the calculation. Others do not. Whatever the methodology or approach taken, the issue for the supply-chain analyst is the monetary value of the CO2 that these calculators say has been either removed from the atmosphere or saved from being emitted by an organisation's products, services, equipment and processors.
In general, however, although the interest in the carbon trading market is high, the new market is largely unregulated and lacks transparency. Government policy in countries such as the USA and Australia is in a constant state of change, and questions of quality and pricing are far from settled. In essence business organisations and individual customers have no way of discriminating (Tanduka, 2007) between providers who claim that in their scheme:
X trees = the sequestration of Y tonnes of CO2 emissions = $Z
There are very few surveys comparing different schemes, and with those that exist, their independence needs transparency checks as well. Currently the auditing and ranking of environmentally sustainable initiatives is in chaos with dozens of organisations offering accreditation and auditing services, across the globe, but none being committed to a standardised methodology for auditing or reporting corporate effort. Walters (2006) lists at least 11 such organisations, none having standards compatible with another. These and other organisations providing CES accounting and assurance are listed in Appendix One.
Once these CES accounting and assurance issues are resolved, there should exist an efficient carbon trading market that would put a price on carbon related activities in terms of a carbon credit (or allowance). Once a monetary value is obtained, cost analysis and pricing decisions along the supply chain can also be undertaken.
In the next issue of On Target: The new paradigm of 'Carbonomics’
Fast Management Reporting Summit 2008
21 & 22 May, Sydney
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Bookshelf
I have referred to the Australian Financial Review's Boss magazine and its associated website (afrboss.com.au) before as an excellent publication, especially for those who are concerned with managing organisations, leadership and innovation. The February issue is no exception. Two articles are on workplace relationships. The first is an article reprinted from the Harvard Business Review (a regular feature of Boss magazine): 'In Praise of Yes Men' by Dianne Coutu (pp42-45) which discusses research that shows what works at home can also help create “chemistry in the office” (in terms of power, conflict and compliance, not romance). The article describes how relationships are based on “accentuating the positive” (as the old song goes) by agreeing without necessarily 'giving in'. Relationships may not be happy ones but should be conflict free.
The second article also considers managing conflict in the workplace: 'Softly, Softly' by Catherine Fox (pp. 50-53). This article is based on an interview with US author, mediator and leadership thinker Mark Gerzon. “Conflict is part of the human condition. Leaders everywhere need a suite of skills to guide them in this sensitive area.” Even though organisations are now less authoritarian and more decentralised, the need for mediation and negotiation skills is still vital. The article raises points from Gerzon's latest book, Leading Through Conflict (Harvard Business School Press).
The February issue also has articles on the challenges of long-term growth by Mehrdad Baghai and Angus Dawson, and the trend towards talent poaching by Emma Connors. There are also sections reviewing new books and recent journal articles.
Bill Richardson
What’s On
10th - 17th February,2008
Mumbai, India
CMA Program conducted by CMA India
14 February, 2008
Bandung, Indonesia
1st Parahyangan International Accounting & Business Conference
15 February, 2008
Brisbane, Australia
Symposium on Accountability, Governance and Performance
Conducted by Griffith Business School
16th -22nd March, 2008
Dubai, UAE
CMA Program conducted by CMA Dubai
13th - 22nd March, 2008
Lebanon
CMA Program conducted by CMA Lebanon
11 -18 May, 2008
Delhi, India
CMA Program conducted by CMA India
May 10 to July 26, 2008
Manila, Philippines
CMA Program conducted by CMA Philippines
August 30 to Nov 22, 2008
Manila, Philippines
CMA Program conducted by CMA Philippines
ICMA endorses Liquid Learning conferences and seminars for CPD.
Endorsed Conferences:
20 – 21 Feb 08
3rd Annual Strategic Management Accounting Forum 2008
Crowne Plaza Darling Harbour, Sydney
21 – 23 May 2008
Fast Management Reporting Summit 2008
Citigate Central, Sydney
http://www.liquidlearning.com.au
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