Chapter 17 Alternative Approaches

Financial Information Analysis2 Copyright 2006 John Wiley & Sons Ltd Introduction Limited perspective of accounting: focused mainly on investor needs difficult to capture non-quantitative elements limited frame of reference Other approaches, e.g. Balanced Scorecard more holistic incorporate non-financial information/outlooks complement accounting perspective

Financial Information Analysis3 Copyright 2006 John Wiley & Sons Ltd Balanced Scorecard (BSC) Financial flows only one element of equation Operational and Human also important BSC broadens frame of reference to include: Innovation and Learning perspective Customer perspective Business Process perspective Financial perspective For each, BSC requires that Goals and appropriate Measures be established

Financial Information Analysis4 Copyright 2006 John Wiley & Sons Ltd e.g. Customer Perspective Goals New products Responsive supply Preferred supplier Customer partnership Measures % sales from new products On-time delivery Ranking by key accounts Number of co-operative efforts

Financial Information Analysis5 Copyright 2006 John Wiley & Sons Ltd Implementation Do’s use BSC as means of strategy implementation ensure goals already agreed and in place ensure top management support customise as appropriate Don’ts use to gain greater ‘control’ use to impose standardisation fail to anticipate and deal with implementation issues

Financial Information Analysis6 Copyright 2006 John Wiley & Sons Ltd Economic Value Analysis EVA derives from economic notion of profit less prescriptive than accounting profit stresses cash-flow implications uses weighted average cost of capital (WACC) EVA = Profit after tax and WACC e.g. Profit £100m; Capital £200m; WACC 8% Economic Profit = £100m - £16m = £84m this would then be augmented by cashflow info. Directs resources to more “profitable” areas

Financial Information Analysis7 Copyright 2006 John Wiley & Sons Ltd Multi-Variate Analysis Integrates financial and non-financial data Used in ‘failure prediction’ models Altman’s Z-score (adapted by Taffler for UK) financial ratios to predict bankruptcy considerable theoretical/practical problems Argenti’s Failure Model failure prediction assigns ‘scores’ under operational areas etc. Efficacy of these models questionable

Financial Information Analysis8 Copyright 2006 John Wiley & Sons Ltd Summary Alternative approaches have emerged in response to limited perspective of accounting BSC and EVA give useful additional and more holistic insights Best used in tandem with accounting data Multi-variate analysis traditionally employed in failure-prediction models Little evidence that they are robust