TRUE VALUE METRICS
BALANCE SHEET
SHOWS THE STATE OF THE REPORTING ENTITY AT A MOMENT IN TIME
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DOUBLE ENTRY
The foundational genius of accountancy is the concept of double entry, and the classification of accounts between balance sheet accounts and profit and loss accounts. Putting it another way, this makes it possible for double entry accounting to account for both state and flow in the same framework.
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Open L0700-CC-Double-Entry
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STATE ... A Balance Sheet Shows State
A balance sheet shows state at a specific moment in time. The balance sheet has been a core piece of financial accounting and reporting for a very long time … it is a big reason why accounting is such a powerful system of economic performance metrics. The balance sheet is a financial representation of the “state” of the reporting entity … it reports on the condition of the entity, whether an organization, a nation or a community.
If you do not know where you are, it is difficult to know where you are going!
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Not only money, but also value
The money balance sheet
The state of an organization is based largely on information reported in the balance sheet. A for-profit entity had assets, liabilities and the owner's equity … that is the investors' equity. Other entities have money balance sheets that reflect the assets and liabilities of the entity based on the money flows and the balances. In the main, the balances are merely a reflection of the aggregate cumulative money transactions.
The value balance sheet
The value balance sheet is a core piece of the TVM framework of metrics. Instead of the balance sheet being only about money in TVM the balance sheet is about the value of the entity … the present value of what the entity has done and will do for value in society.
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Not only an organization focus, but also people and place
In the TVM framework, it is not only the organization that is the focus of analysis, but people and place or community as well. The value of economic activity is the improvement and maintenance of quality of life for people. Community is a place where people live, and a place has truly long term if not perpetual existence. Place is also a good proxy for planet, because what happens to the resources and environment in a place translates to impact on the planet.
TPB Note: Facts about my own little home town of Okehampton in Devon, England are recorded in the Domesday Book compiled by William the Conqueror shortly after his invasion of England in 1066. The town did not grow much in almost 900 years!
The balance sheet of a community is the main analytical and reporting focus. The balance sheets of organizations, projects and other economic activities are subsidiary to the community … and are aggregated or consolidated into the community balance sheet.
Any entity that might use standard money accounting can just as well use the TVM methodology. The system works for all organizations whether or not they are for profit or not-for-profit, whether they are in the private sector or in the public sector, and whether or not they are large or small.
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Balance sheet has assets and liabilities
A business balance sheet … a money accounting balance sheet … has assets and liabilities, all of which relate to money transactions of one sort or another. There are money accounting rules about how the assets and liabilities are recorded and included in the financial reporting.
A TVM value balance sheet has asset data representing good things in the community, and liabilities which are bad things in the community. The value balance sheet has much in common with a money accounting business balance sheet. The money accounting balance sheet has assets and liabilities about all the money elements of the community … and these are part of the value balance sheet. In addition the value balance sheet has data about elements that relate to quality of life and the latent potential of the reporting entity.
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Assets
The resources of the community are an important part of the foundation for progress of the community. Though the community may not have a lot of money, there may be many other material resources, as well as the human resource that can be the driver of sustainable progress.
There are 7 main asset elements with both money and value dimensions:
- Land ... natural resources;
- Labor ... people, human resources;
- Capital ... money, financial resources;
- Physical capacity ... infrastructure, production capacity, organization;
- Intellectual capacity … science and technology, know-how, enabling environment;
- Organizational capacity; and
- Governance and the enabling environment.
Value balance sheet starts with money balance sheet elements … but the quantification of the elements is not the same. TVM includes the value of the elements in the balance sheet as well as the cost
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Liabilities
Constraints and “lack of” are treated as liabilities in the value balance sheet. While money liabilities have the same form in both money and value balance sheets, the value of activities and issues that constrain progress and performance of the community are the treated as value liabilities. The 7 liability elements mirror the value assets thus:
- The lack of land ... natural resources;
- The lack of labor ... people, human resources;
- The lack of capital ... money, financial resources;
- The lack of physical capacity ... infrastructure, production capacity, organization;
- The lack of intellectual capacity … science and technology, know-how, enabling environment;
- The lack of organizational capacity; and
- The lack of governance and the enabling environment.
Constraints are liabilities in the value balance sheet. Constraints may be either an active limit on what progress may be achieved, or something passive like the lack of something that is critical. Examples of active constraints may be the enabling environment, the framework of law and insecurity. Examples of passive constraints may be lack of water, lack of money, lack of infrastructure, and so forth.
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Elements of the Balance Sheet
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Land … Natural resources
As assets
Land and natural resources have been important drivers of wealth creation … and in large part the history of wealth is also the history of natural resource exploitation. Natural resources in a community should be considered as important assets of the community. There are a host of issues associated with natural resources and their use for the benefit of the community. Many of these are constraints that impact the community and the opportunity of the community to make socio-economic progress.
- Land is an important natural resource and frequently constrained as to use for the benefit of the community by ownership issues.
- Forest and trees are important
- Rivers and water are important
- Minerals and energy resources are important
- Wind and tide may have value
There are many different resources. In classical economics where agriculture and trade were the dominant economic activities, the resources needed for economic activity were identified as land, labor and capital. Modern economics builds on these ideas and the role of many intangibles is now taken into account in a more complete manner.
Liability is a lack of these things
A community is constrained when it does not have enough land and natural resources. A community may adapt … but it may not.
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Labor … People / human resources
As assets
In money accounting, people are not part of the balance sheet, though their performance makes a huge difference in profit performance. In the TVM framework people are reported as the asset they are.
There has to be care in the handling of data about people which may be constrained by legal issues of one kind or another. Many facts about people may not be shared in the public space because of law and regulation.
People are very important. Especially in the community … without people there is no community. It is people that are the beneficiaries of quality of life and opportunity. People are also the source of labor, creative ideas and intangibles like friendship. People are family … and people are community! People are the most important resource in any place … way more important than money.
What value is a person? What value is education until it is part of a person's capacity. So also what is the value of good healthcare unless it is part of a person's capacity. And what value is a person unless there is opportunity to do something of value with the person's capacity! There are multiple attributes that go into building the value of people in society. The value of a person can be quantified based on the various attributes of the people and the community.
Sustainable socio-economic progress depends on people … human capacity and the human resource more than any other resource. In the end, the human resource is the one that will facilitate or constrain progress and performance. The key, therefore is to enable people to be the energy that drives socio-economic activity and the production of goods and services. In a modern society, it is people who get benefit, but it is also people who work to produce the benefit. A program that has people focus and has a dynamic that is people centric can be sustainable.
People define the needs … and people are the most important resource. When this is the thinking behind the way the planning is done, development becomes an investment with a return and not merely an expenditure. Modern economics recognizes the dual role of people … as people with needs … and as people that produce to satisfy needs. In other words, people are more than merely a factor of production, they are also the driver of demand.
Liability is a lack of these things
The lack of labor ... people, human resources is a constraint. The lack of labor is a liability … the lack of capacity in the population is a liability. If people are a valuable resource, the lack of people is a constraint and a liability. The constraints associated with the population are a function of matters like the history of nutrition and health, the history of education and the history of the community.
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Capital … money and financial resources
As assets
Money resources are important. Money is needed to serve as a medium of exchange, and to some extent a store of value. But the biggest reason for money resources is to pay salaries and to pay bills and to be part of the broad money economy. Without money an organization has to close down or go into a dormant state. Good ideas disappear when there is not money to sustain a framework for the ideas to develop and perhaps flourish. Almost everything that is needed, whether goods or services must be paid for with money … or money equivalent.
Credit is a money equivalent, up to a point. The assumption is that money will be available in the future … and if this proves to be wrong, then the “credit” disappears.
Liability is a lack of these things
The lack of capital ... money, financial resources … and the lack of credit is a constraint and recorded as a liability
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Physical capacity … buildings, infrastructure, etc.
As assets
There are two levels of value associated with buildings (1) the satisfaction of the basic need for shelter; and (2) the buildings needed to support quality of life and the productivity of society.
The basic need for shelter is very important in the present circumstance of Haiti. With as many as 250,000 housing units destroyed in the earthquake there is a very large need for basic shelter.
Many of the major commercial and governmental buildings have to be rebuilt
- Roads and bridges determine the efficiency of transport.
- Internet and telephone infrastructure determines the efficiency of communications
- Various types of equipment determine productivity in the activities of the society
- Working capital is part of this. Business activity needs working capital … inventory and the ability to finance trade transactions.
Liability is a lack of these things
The lack of physical capacity ... infrastructure, production capacity, organization … is a liability.
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Knowhow … intellectual capacity
As assets
Science and technology … know-how
Know-how is a key enabler of progress. In fact it is the growth of knowledge over the past 200 years that has made it possible for global society to progress so rapidly. The growth in knowledge has been far more rapid than the growth in the application of knowledge. Worse, the application of knowledge has been for both bad and good.
Enabling environment: Governance, Rule of law
Liability is a lack of these things
The lack of intellectual capacity … science and technology, know-how, and an enabling environment are liabilities
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Organizational capacity
As assets
Organizational capacity contributes to economic productivity. Organizational capacity has value … it is very important in making it possible for the economic activity of the community to be productive. Productive economic activity is surplus producing and helps a community progress.
An individual is very limited in what he or she can do alone … but when individuals work as a team all sorts of amazing things can get done. Organization is needed so that things can get done … and organizations are a way for organization to take place. It is organizations that do things, create jobs and make it possible for there to be progress.
Organization is needed to have productive activities. Most activities may be initiatives of the private sector … private organizations, and using private capital. In a functioning economy most activities are paid for by the beneficiaries of the activities.
Being organized is an asset. The challenge is to be organized so that there is a structure within which (1) there can be financing; (2) there can be wage employment; and, (3) there can be socio-economic value adding.
There are many legal forms that are possible … depending on the prevailing legal framework and the way the community wants to be organized or structured. From an accountant's perspective the key elements are: (1) the funding of working capital so that wages can be paid; (2) the balance sheet value improvement that results from the work done and the payment of wages; and, (3) the monetization of the value improvement so that the funds mobilized may be repaid or recirculated.
Liability is a lack of these things
Liability is the lack of organization … organizational capacity
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Governance and the enabling environment
As assets
Governance is a matter that may facilitate the progress of a community or constrain it ... governance may therefore be an asset or a liability. Governance is an asset when it provides an enabling environment for progress ... otherwise it is a liability.
Money liabilities are amounts owed by the entity to others ... a fairly simple concept.
The concept of liability in value terms is more nuanced. Essentially a liability is a lack of an important asset needed to satisfy community needs.
Liability is a lack of these things
There are two ways in which constraints are manifested: (1) by specific things that stop activities or limit productivity; and, (2) by the lack of things that are needed to have productive activities in the community. Crime is a specific thing that stops activities and limits productivity. Lack of land, for example, constrains agricultural activity.
In TVM value accounting there is value in having the capacity to satisfy needs ... that is Tier 1 needs. Conversely there is a value liability when such capacity does not exist. The same analytical logic applies to all the types of capacity.
The lack of governance and enabling environment
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Off Balance Sheet Items
The money accounting rules
The money accounting rules have been changed over time so that many important financial matters are routinely excluded from balance sheet reporting. This is a dangerous state of affairs brought about by “law based” money accountancy that allows wrong principled reporting to take place. It is very convenient for business organizations to be able to legally lie about the financial condition of the organization.
Unfunded pension liabilities are one of several major issues that are reported in a convenient way rather than in a complete and correct way. There are others.
Contingent liabilities
But the concept is less clear when there is conditionality about what is to be paid and where the calculations are complex. Liabilities that might be very large when a set of conditions apply, but may not exist at all if other conditions apply create a huge risk for anyone relying on financial analysis of the entity.
TPB Note: I was part of an investment group that almost acquired a shipbuilder in Florida. There was a good business plan and the future of the acquired organization looked good ... but there was one problem. The shipbuilder built mainly fishing trawlers, and there was the potential for a lawsuit related to one of the company's trawlers sinking in a storm in the Atlantic with loss of life. While all the normal insurance protections were in place ... there was a small possibility that there might be a counter-claim about a deficiency in design, or something along those lines. Even though several hundred vessels of this or similar design were in use ... this contingent liability was sufficient to stop this transaction from closing.
Risk
Change is a risk … and a poor community is likely to be risk averse for good reason. The matter of risk must be taken into consideration and risk managed appropriately.
It should be noted that “risk” is an issue that is almost totally ignored by the wealthy who one might say “self insure” and do not get hurt very much when things go wrong … while the poor have to endure even more hardship when risks hit society, and they are caught up in the damage that ensues.
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Winning the Game! What Game?
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More and more … of what?
So much of modern progress has merely been doing more and more of what, arguable, the world neither wants or needs. A huge effort has been expended in trying to create wants and needs … for not good reason.
The world has achieved an amazing capacity to produce … something never achieved before at any time in human history, but the metrics about socio-economics are pushing for production of all the wrong things … for things that produce profit and rarely if at all those things that would satisfy needs … be valuable, without being profitable.
The prevailing metrics are wrong most of the time, something that is terribly dangerous for the future of humankind andf the planet.
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Maximizing quality of life
In the money metrics construct winning is more and more of money and material goods … with quality of life assumed to improve with more and more of these things.
Keeping Score
In sports, scorekeepers keep score and the score tells which team it is that wins. Society is similar … with the present money metrics system of scoring, winning is about more and more money. In a value based society winning will be maximizing quality of life … the values that make life worth living.
TVM thinks of progress as winning the game … and maximizing quality of life. This is not a money construct but a value construct and way more complete as a system of metrics than mere money and money accounting that has changed rather little since it was devised in its modern form some 400 years ago. In TVM, progress … maximizing the quality of life … has a central role, just as profit has a central role in the business entity and the money metrics of capital markets.
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