TrueValueMetrics ... Impact Accounting for the 21st Century

Technology is rarely talked about as the underlying driver of socio-economic progress ... but it can be argued that this is, in fact, the single most important factor ... that it is technology that is giving us opportunities that have never before been possible, and it is technology that provides the constraints to what progress is possible. In ancient times, the great civilizations were all associated with some development of understanding of technology ... the Egyptians, the Greeks, the Romans, the Vikings. In more recent times the agricultural revolution, the industrial revolution and now the knowledge revolution. Modern engineering thermodynamics provides a good framework for thinking about social performance.

There are engineering balances that are fundamental ... work and energy .. efficiency. These ideas translate very well into the performance of society. CA is grounded in some very old basic concepts of thermodynamics and accountancy and measurement.

CA also embraces 21st century technical possibilities. In simple ... perhaps simplistic ... terms, CA is like Facebook except that the central focus is a physical community rather than “me”. With CA, the connections are not “my” friends and interests, but the people, organizations and issues that influence or impact the socio-economic performance of the community. CA is structured so that the data about a community is organized in useful ways, rather like the way corporate accounting information is organized into accounts and different datasets that make it easy to understand corporate performance. CA uses some of constructs that make corporate accountancy powerful ... but does not limit itself to just money transactions, but also embraces activities and initiatives that affect socio-economic well-being.

Getting Beyond Financial Metrics

The analysis of the global economy has been driven for a very long time by metrics that were keyed around financial ideas. The most important measure of all was financial profit ... as well as wealth, the ownership of things that money could buy!

An economic analysis system based on production ... the communist system ... eventually failed because the allocation of resources under this system was inefficient. Relative to this system the money metrics and market based optimization of profit system did much better ... but is also deeply flawed. The system serves to allocate resources so that there is a maximization of profit, but at the expense of value.

Dr. Muhammad Yunus
Dr. Muhammad Yunus has made the observation that metrics that only have the money dimension are inadequate. There needs to be a system of analysis that takes into account the full range of social values ... not just those that get denominated in money terms!

CA is built around the idea that there is a need for information that will guide decision makers along the lines described by Dr. Yunus. The logic of a financial accounting system is a good starting point ... and with CA is enhanced to include not only money transactions, but also transactions that reflect the consumption of value and the creation of value. Corporate financial reporting is very efficient ... making it possible for a huge organization like, for example, General Electric, to report in three pages the activities and results of perhaps 300,000 people. This is done using a Balance Sheet, a Profit and Loss Account and a Statement of Cash Flow. The principles of accounting make financial reports informative without being long with a lot of disorganized detail.

It should be noted, however, that the principles of accountancy have been systematically diluted over the past forty years by lawmakers, regulators and rule making bodies at the behest of special interests. The result is that modern financial reports rarely represent what is true and fair as they did in older simpler times. This, more than any other single factor, explains the abysmal state of financial reporting in modern corporate organizations ... when excellence in management information is perfectly possible.

Transparency and Accountability

Transparency and accountability are important ... but impossible to have without an appropriate structure for data acquisition and analysis. CA provides such a structure. CA has ambitious aims ... to make it possible for the public to hold decision makers accountable.

CA has a structure that allows it to work even when major socio-economic actors are not participating in any way. While the non-participation of these actors makes data acquisition more difficult ... it is not impossible ... and it is even more important.

Simply put ... it may be possible for an economic actor to hide how it operates internally, but it is impossible for any substantial economic actor to hide from the impact of its activities. Inappropriate activities with anti-social outcomes are only sustainable when there is no visibility for these activities and outcomes!

The concept of double entry described later creates a very powerful tool for financial control. Either there is the money that can be counted or there is the product or service that has been bought. The money value representation of the one equals the other. When money buys less than it should ... this can be identified. In a good system of accounting, the double entry characteristic can be used to ensure that nothing is stolen without more than one person knowing about it!

Cost ... Price ... Value

Three key numbers: cost, price and value

Cost, price and value are very important numbers about any economic activity. Though modern society is founded on economic activity, there is a surprising lack of information about cost and value though there are massive datasets about prices. ... that is what a buyer pays for a product or services, and what prices stocks and other financial interests are trading at, what prices commodities are trading at, etc. There is by contrast almost no data about costs ... and even less organized data about value.

Cost

Money cost is what gets paid for someone to have a good or service. Money cost is also the use of resources to create a good or service ... the aggregation of all the elements of cost that go into creating something. Elements of cost are things like: labor; materials; operating expenses, admin and overhead expenses, depreciation and financial costs. In most good organizations, cost accounting is detailed ... and often very informative ... but also maybe overwhelming. Standard costs and variance analysis are methods that help clarify cost data and identify variations that need explanation.

Price

Price is what is being paid for the item ... price is the money received when an item is sold. For a buyer, the price is a cost ... something of a conundrum that confuses analysis! And price may be value ... but usually is not. The price is merely what an item is traded at ... and may or may not have anything to do with value. Many factors influence price ... and where price is determined by market forces, there are many factor that influence the behavior of prices in a market.

Value

Value is subjective ... and more difficult to quantify. Value is arguably far more important than money cost and money price. The challenge with value accounting is how to have numerical values that are an integral part of the system. The CA solution to this is to have elements of value, just as there are elements of cost, and to have standard values that reflect the perception of value that people have. From this it becomes possible to have standard value profiles for a community ... and from this to create reports that reflect the consumption and creation of these values. The difficulty with using value in metrics is that value is subjective and therefore not easy to quantify ... but value is much more at the core of socioeconomic performance and quality of life than anything else.

Derivatives of Cost, Price and Value

Profit ... derivative of money cost and money price

The simple definition of profit is based on money cost and money price. In financial accounting and reporting to corporate stakeholders, profit is the key measure that drives everything.

But profit is more complex in modern financial accounting. Money profit is no longer just the delta between price and profit but might be something else. The accounts may not simply record assets at their cost but on some other basis ... including “mark to market”! This is a wonderful device for taking into account unrealized profit ... simply by recording their value in the balance sheet at a price that the assets could be sold for based on the present market. Fifty years ago, a practice like this would have been banned absolutely based on the prevailing accounting principles ... but lobbying and legislation has overturned old principles and replaced them with laws and rules that are convenient ... in a rising market ... and very dangerous at any other time! Convenience is not a good principle of accounting.

Profit is at the center of the capitalist economic construct ... and is a useful metric as it relates money revenue with money costs, and serves as a useful and practical proxy for performance and productivity. But profit is is not a good proxy for socio-economic performance and the way quality of life in a community changes ... nor the sustainability of the community. In fact, thoughtless optimizing or maximizing of profit is a fairly certain way of creating an unsustainable future.

Value adding ... derivative of value and cost

If, rather than just money, the metric of performance is value adding ... that is the increment of value from an activity, then there is a very much better measure of progress and performance. Value ... that is value to society ... is almost totally excluded from modern financial and economic metrics. The reasons are many including (1) it has a subjective dimension that makes valuation difficult; and, (2) it has a devastating impact on the norms of financial valuation of corporate activity.

Cash flow ... derivative of money cost and money inflows

Cash flow is a metric that relates to sustainability in a world where money is the medium of exchange. Cash is used to pay bills. Money inflows may come from revenues which are a function of price, or they come from financing or some change in the balance sheet like sale of assets. Activities that result in a persistent cash deficit will fail in due course, simply because the money runs out. The timing of the demise of the activities may be delayed by borrowing ... but that also will fail in due course.

Sustainability

Activities that have value adding positive and cash flow being positive are sustainable ... and desirable.

Activities that are cash flow positive and profitable are money sustainable but maybe not socioeconomically sustainable ... and these activities have come to dominate rich developed economies in the post World War II period. By ignoring critical issues of value destruction society had the impression of wealth being created ... but much was mere puffery and the balloons were bound to break. But worse, society built the appearance of wealth while setting the stage for potentially catastrophic global disasters in the future.

Organized Data

Data organization - accounts

Accounts are a way of getting a lot of transactions ... that is debits and credits ... organized so that they can easily be understood. All of the cash transactions are recorded in one account ... the cash account. All of the goods received and goods delivered are recorded in one account ... the stock or inventory account. So with other similar transactions ... similar transactions all together in one account.

CA goes beyond the corporate system of accounting so that there is a similar rigor for recording social value as the corporate system has around recording revenue and profit.

Data organization - account codes

Account codes are important in accountancy ... they make organizing a lot of data much easier and especially, account codes facilitate easy rapid analysis. The logic of account codes makes it possible for there to be “roll up” and “drill down” that are easy and make sense. The structure of the account codes in themselves tell a story about the organization!

Data neutrality

Data must be independent and neutral in order for any of the analysis and conclusions to be credible. The value of CA is enhanced by having the data and analysis independent and neutral. In fact, independence in collecting and processing the data is essential for credibility.

It is essential that data are credible. This may best be achieved by some level of independence in data collection, as well as independent checks. It is possible for those with an interest in the outcome to be a part of the process of data accumulation, but they must never be the sole source of data. The data may be contributed by anyone ... and data may be validated by anyone. The data may be used by anyone who is working to improve community progress. While anyone may contribute to the CA dataflows, there are internal checks to ensure that the data and analysis remain objective and independent.

Scientists face the problem of measurement that changes what is being measured ... this and more apply in the area of socio-economic measurement. If people can they will manipulate the data so that they look good ... this is human nature ... but it makes a nonsense of the data and any subsequent analysis. Good corporate accountancy addresses this problem seriously with independent accounting teams and systems that cannot be manipulated by the operating staff. Good corporate accountancy goes further with systems of internal check to ensure the data remain untainted ... and on top of this there are both internal and external audit functions. CA facilitates multiple independent flows of data that enables a range of cross checks and validation.

Logical Framework

The double entry concept

The logical framework for TVM and Community Analytics embraces the double entry concept that has been used in the corporate system of conventional financial accountancy for a very long time. The financial accounting and management systems used in modern corporate organizations have evolved from a system of accounting that was developed several hundred years to enable merchant adventurers to keep accounts and report to the investors who had financed their voyages. Double entry is a simple technique that requires both action and response to be recorded ... when money is paid out, it is expected that value comes in ... when some good is delivered, it is expected that money is paid for that transaction.

Financial balance sheet

Corporate accountancy uses the balance sheet to describe the state of the organization. The balance sheet describes the financial state of the organization at a given point of time. The balance sheet provides a listing of assets, a listing of liabilities, and shows the difference between the two.

Changes in the balance sheet over time are a result of activities in the time period. The net change from one period to the next in the balance sheet is the same as the net of revenue and cost or profit in the activity report. The net change in the balance sheet from the beginning of the period to the end of the period is the same as the net result reported in the activity statement.

The assets and liabilities of a balance sheet are accounted for at their cost ... reflecting the double entry of cash used equals asset acquired ... and liability acquired will be satisfied by cash paid. The listing of assets and liabilities can be in summary or detailed.

Activity reporting

The activity report ... the profit and loss account ... describes the operations of the organization for a specified period of time and the relationship of revenue to cost and therefore profit. There are innumerable formats for activity reports ... and many different names. They may be prepared with a lot of detail or be very much summarized. To a great extent the public and external stakeholders get summary reports and internal managers and staff work with reports at the appropriate leve3l of detail.

The data contained in activity reports that is usually hidden from external view would serve very well to improve transparency ... but few corporate organizations embrace this.

Integration of balance sheet and activity reporting

This integration of balance sheet and activity statement comes about because of the double entry characteristic ... and provides a powerful way of understanding a lot about an organization without needing to know everything about an organization ... or community.

This concept underlies the ideas of balance sheet, operating statement and the relationship they have to each other ... specifically that the the net change in balance sheet value between two dates equals the income from the operating statement between these two dates. Corporate accountancy uses both balance sheet and an activity report to describe the organizations performance. The balance sheet describes the financial state of the organization at a given point of time and the activity report ... the profit and loss account ... describes the results of operations of the organization for a specified period of time.

The net change in the balance sheet from the beginning of the period to the end of the period is the same as the net result reported in the activity statement.

Cash flow statement

A cash flow statement is similar to an activity statement but has a focus only on those transactions that have a cash impact. For example, some accounting costs, such as depreciation related items, do not have a cash element. In the logical framework, changes in the balance sheet, activity reporting and cash flow are all different views of the same comprehensive set of data.

State of the community

The state of the community is a similar construct around value as the financial balance sheet of a corporate organization is around money denominated assets and liabilities. The community has many assets ... many asset classes ... and liabilities or constraints. In CA a value is attributed to all these assets and a negative value attributed to the liabilities and constraints.

The asset classes include everything of value to the community ... tangible and intangible ... money denominated or not. People are valuable ... human capital if you will. Natural resources are valuable ... and their use and depletion is important and must not be ignored in the metrics. Knowledge is important ... as is organization, governance, security, spirituality and happiness. The CA goal is for everything that contributes and makes up quality of life to be taken into account.

Change of state from time one to another time two is the main CA metric of progress. Corporate progress is the net change between two balance sheets ... in CA progress is the net change between two states of the community.

Value change activities

Value change activities ... socio-economic activities ... are the activities that are going on in society. It is these activities that change the community state from state one to state two ... value adding activities improve the state of the community and the quality of life ... value destruction activities produce a deterioration in the state of the community and quality of life. It is possible to know whether there is progress or not merely by looking at the change of state of the community, but it is understanding the value change activities that makes it possible to understand how the community is performing.

Incomplete records

In financial accounting, a meaningful report can be prepared from incomplete records because the balance sheet and the operating statement are related. This same idea is available in the CA logical framework so that performance can be measured reliably and usefully merely by the comparison of the community state from one period to the next, and some modest information about the activities that might be the cause. By using change in state to identify what changes are important, it is possible to focus attention on issues that should be addressed as a priority. By analysis of the state of the community it is possible to identify what issues are an absolute priority for the community.

Progress and Performance

Keeping score ... who wins?

The system of measuring financial performance and economic performance does not have the easy clarity of keeping score in sport.

Who wins?

In almost any sport there is a scorekeeper ... and it is very clear who is the winner. In soccer, the number of goals scored, in rugby and American football, the number of points scored, in baseball and cricket, the number of runs scored, in tennis a system of points, games and sets! ... and so on. But the system of measuring financial and economic performance does not work in this way. There is a fundamental disconnect between what the key measures should be and what they actually are. In the most simplistic way, it can be said that the financial and social measures are all about money ... and not much else. Economists may recognize externalities ... but they ignore them in their mainstream measures.

The CA approach, on the other hand, makes value the measure ... which might be a money metric or something else. Performance is better when there is more value being created for a given amount of resource use ... and resource use includes the idea of consumption or destruction of value as well as simply the use of money related resources.

Change in State ... Measure of Progress

CA draws on the experience of financial reporting. CA reporting aims to be clear and relevant, and does this by reporting in a modular manner around issues that are material for the community. The first level of CA reporting is the comparative balance sheet. How do key matters of the community change from period to period, that is year to year, or month to month, or at even more frequent intervals.

CA has a community focus treating the community as the reporting entity. The rules for consolidating accounts apply as all the subsidiary units doing economic activities in the community are brought into account. CA includes transactions that reflect value as well as the normal money transactions. CA is more accountancy than a statistical construct. The data are as simple as possible ... the transactions as small as possible, as many as possible and as clear as possible. Some of the value of CA derives from how CA can do accounting for community progress. In the following graphic ... the value of the community at the beginning of the period is the same as it is at the end of the period ... the community has gone about its business for the period, the time has gone by, but nothing has changed.

Ordinary activities produce no change

Data about the daily activities is not needed in the CA system in order to be very clear about progress ... whether it is progress or problem. All that is needed is data about the value changes that have taken place from the beginning of the period to the end of the period as shown below.

GOOD ... progress

OOPS ... problem

The reason for numbers ... to keep score Numbers are a very efficient shorthand. Almost all scoring systems use numbers. Examples of scoring systems

Golf: The number of strokes used for the round. Lowest number wins.
Cricket: Number of runs. Largest number of runs wins.
Tennis: Numbers of winning points wins a game. Most games won wins a set. Most
sets won wins a match. Most matches won wins a tournament.
Baseball: Number of runs. Largest number of runs wins. The system of runs is quite complicated, but simplifies to number of runs to determine the winner.
Soccer: Number of goals scored.
American football: Number of points scored ... with points assigned for different winning actions: touchdowns, conversions, field goals, etc.

Measuring performance

CA has its origins in technical engineering measurement, economic measurement and corporate accountancy. A key feature is simple but powerful organization of data so that they are useful without creating unmanageable data overload.

It is rare to find people in charge wanting to have objective independent measurement. Far too many measures make it possible for responsible managers to avoid accountability.

Development aid

Over 60 years there has been more than $1 trillion disbursed for development. This should have produced great progress ... but what has actually been achieved? Far, far less! Yet monitoring and evaluations mostly show that projects have achieved budgeted objectives. Please ... what is going on? Performance is more than just a number ... it is a number in a specific situation.

Speed

I am traveling at 6 miles an hour. If I am in a car this is slow. If I am walking or running it is fast! The context matters!

The progress of science and technology has been spectacular over the last century ... but too much of this has been used in ways that have done damage rather than good. Military engineering has adopted new great science faster than civilian engineering ... with predictable results. The application of science has followed financial profit and rarely social value.

Social progress ... peace and prosperity

Science and technology ... knowledge about these things has improved exponentially over the past 50 years along a trajectory driven by, inter alia, Moore's Law. But for much of middle class society times are tougher. Why? Performance of leadership ... of public policy and its practice ... has been poor.

Cost efficiency

Cost efficiency is a measure that relates how much an activity did cost with how much much it should have cost?

How much something should cost is determined by reference to experience, technical factors and prices. It is possible to calculate how much something should cost if the elements of the activity are understood.

If experience in other situations is known, this may inform how much something should cost in another situation. What something should cost may be expressed as a standard cost.

Cost effectiveness

Cost effectiveness is a measure that relates how much impact or value was achieved with the use of resources ... it is a measure of productivity.

Understanding performance

It is not enough just to know the performance ... but also the how and why of this performance. Socioeconomic performance can be improved in just the same way that a team sport is improved.

Who played well?

In sport the fans want to know more than just the score! They want to know how the game was played, and who were the players that helped give the winning team the victory. The coash wants to know the details ... so that the game can be played better next time!

The understanding of performance has helped the corporate world improve their productivity performance way beyond what was expected ... and the productivity improvement translated into more profit and more stockholder value. The metrics were all that the corporate stakeholders needed ... but the metrics were inadequate for society at large. What is the social advantage arising from a job in one country versus a job in another country ... who to whom does this advantage accrue. The data are not particularly sophisticated, but the understanding of what the data are showing maybe very important, complex, and multi-faceted.

Feedback ... Reporting ... Facilitating Change

Analytical and reporting efficiency

There are many ways to measure and report performance ... no one way is the “right” way ... but some are better than others. The key concepts of reporting in accountancy are very efficient. The principles of accounting make corporate financial reports informative without being extremely long and full of disorganized detail.

Powerful ... not voluminous

Corporate financial reporting is very efficient ... making it possible for a huge organization like, for example, General Electric, to report in a very few pages the activities and results of perhaps 300,000 people. This is done using a Balance Sheet, a Profit and Loss Account and a Statement of Cash Flow.

Management information

The purpose of management information is to improve decision making.

“Management information is the least amount of information that enables a good decision to be made reliably and in a timely way.”

Accounting provides data that are a good starting point for management information. Relating operational key data with accounting information makes it possible to address issues that are important and will make a difference.

And a Whole Lot More

Metrics ... what gets measured gets done

Metrics are very important ... because what gets measured gets done. This is more powerful than the measures themselves might suggest, in part because of the deep complexity of people both individually and as a group. CA measures ... CA considers the measures to be important ... and things get done!

“What gets measured gets done”

Materiality

Materiality is a very simple concept. Put focus on things that are important. By having a focus on material items, reporting can avoid getting overloaded with detail that matter little. Using materiality in reporting does not mean lesser matters are ignored ... everything is in the purview of the data acquisition ... and monitored. Materiality is based on a full range of data ... it is not a supposition unsupported by data.

Roll up and drill down

Community is a place ... and all communities should “add up” to a larger place, that my be a district, or a state, or a country. In this perspective of community there is no spatial overlap. Within a community there may also be neighborhoods ... and within neighborhoods also blocks.

Community may also be based on a group interest ... an affinity group. This may overlap the community defined by geographic area. A note of caution ... the “roll-up” or aggregation of affinity groups is complex and should be done carefully and rarely used as a national or global aggregate.

Accounting creativity

Accounting creativity has no place in the logical framework of accountancy ... but such creativity has been given a place by allowing basic accounting principles to be subverted by laws, rules and regulations that are convenient but not principled.

Wrong ... any way you look at it!

Law, rules and regulations that allow important liabilities to be left off the balance sheet of a corporate entity are just plain wrong ... though law makers can make such reporting legal.

Companies like General Motors were allowed to report in this manner for years ... but in the end real reality caught up with the legal fiction.

Banks and financial organizations were allowed to report unrealized profits on their asset portfolio using a “mark to market” construct ... but it caught up with them when the real world market stumbled and the real value of their assets turned out to be a fraction of the reported balance sheet values.

This reporting is wrong ... any way you look at it!

Rebuilding accounting integrity

The principles of accountancy have, over the past forty years been systematically diluted by lawmakers, regulators and rule making bodies at the behest of special interests so that modern financial reports have less reliability now for representing what is true and fair than in the past. This, more than any other single factor, explains the abysmal state of financial reporting in modern corporate organizations. The integrity of accounting ... and audit ... has not been served well by the profession.

This can and must be changed. The TrueValueMetrics initiative is a step in this direction.

Modularity

CA starts with the assumption that there are already a lot of ongoing economic activities. There is a need to start keeping score in a meaningful way as soon as possible. One way to do this is to keep track of just some part of the economic activity in the community ... preferably some part that is important. Things that are not changing fast may be taken into consideration later.

Caveat

To use the sporting analogy ... the game is already going on. How do you make some useful contribution as a scorekeeper when the game has already started? One way is to find out what has already happened and start off with the score as others are reporting it ... and then to keep score on a continuing basis from that point on. This seems reasonable.

The KISS principle

Keep it short and simple ... KISS ... is a useful idea to keep in mind. The best data are data that can be easily collected, easily understood, easily checked, reliable ... and useful. CA is committed to the idea that CA data must have this characteristic ... but that the data should also be useful for more complex analysis as well as having a local community use.

Inclusive

CA has the view that all economic aspects should be included in the CA framework ... a stark contrast to some corporate accounting that has taken the view that some economic transactions should be kept off the balance sheet. Anything and everything that has an impact on quality of life, standard of living, pursuit of happiness, etc. should be taken into consideration. The CA embrace of both value and money revenue is the core of CA's approach. Value is included rather than being merely a sidebar as it is in modern corporate accountancy.

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