How much is that doggy in the window? Woof Woof!

In traditional finance, one uses enterprise value or equity value to price a business.  Think of it as the takeover price.  In a buyout, the purchaser would not only take on the company’s cash but also its debt.  Enterprise value is one of the more conservative valuations because it takes into account the entire balance sheet.  Other valuations focus only on share price or more limited aspects of the financial statements.

Many businesses were allowed to adopt fair value accounting standards in 2006.  The purpose of adopting this standard was to convey to financial statement users a price that could be received between a knowledgeable buy and seller.  What was known as Statement on Financial Accounting Standard 157 (SFAS 157) at the time, allowed for companies to measure assets and liabilities on their balance sheets at “market price.”  Determining a market price can be subjective, and incredibly difficult, when you can't easily observe an asset or liability being actively traded in a market place.  

In trying to understand the current financial crisis, the spotlight has turned to fair value accounting and financial institutions.  Shortly after the Financial Accounting Standards Board (FASB) issued SFAS 157, the problems related to the subprime mortgage market began to surface.  Many began to question whether or not the current distress in financial institutions is related to the new accounting standard.  Did the new standard exacerbate the problems or merely illuminate them?  Many are still debating this six years later. 

In October 2008, then-President George W. Bush signed into law the Emergency Economic Stabilization Act of 2008 (EESA), the so-called bailout bill. Under section 132 of the EESA, Congress gave the SEC the authority to suspend the use of fair value accounting under SFAS 157.  Section 133 requires the SEC to conduct a study of the fair value accounting as stipulated in SFAS 157.  Note that in Section 133, Congress even calls on the SEC to "review the process used by the Financial Accounting Standards Board in developing accounting standards."  This is a much broader mandate than just studying a single accounting standard.

Has the value we placed on numbers outlived its purpose?  Despite the down falls accounting and finance figures may have, we still need them.  They give us a baseline and can provide us with a lot of insight into an entity’s operations.  If you were valuing a business using fair value accounting back in 2008, you may have grossly overestimated (or maybe underestimated) the takeover price of the business.  Hindsight is always 20/20 but what writing was on the wall that we may have turned a blind eye to in order to avoid seeing what we didn't want to see?

What I would caution people to do is to not stop at the numbers.  Go beyond that.  What external factors affect the business?  How is the economy doing?  What is the morale of the workforce?  How quickly is this business able to pivot as this world evolves?  How important is strategic planning to the organization?

What all of these valuations fail to do is take into account the triple bottom line.  Perhaps that’s because it’s not easy to place values on the earth and its people (and perhaps doing so would further damage our world).  In order for us all to be part of the paradigm shirt this world needs, the value of the health of our people and planet must be valued the same, if not more than, as our traditional monetary measurements.