Value-Based Accounting Can Add Value
Financial Accounting Standard 131, which went into effect at the beginning of this calendar year, changes the way all publicly traded banks report information about segments of their business.
It requires selected segment information in quarterly and annual reports to shareholders.
The task facing banks is how best to gather the information needed to comply with FAS 131 and present their story.
One solution is to install an economic profit (EP) or value management system. There is renewed interest in this type of system, which is currently used by only a handful of banks.
Unlike other operating measures such as returns on assets or equity, economic profits, the metric used in value-based systems, is a dollar measure of performance. It represents the value created by a bank in the period being measured.
More important, the system can be leveraged to achieve targeted gains in shareholder value.
Used properly, the system can help develop capital allocations, hurdle rates, and operating measures of value creation for the corporation as a whole, business lines, or geographical regions.
An EP management system installation can also identify the key value drivers for lines of business, and measure value-creation strategies, including those for acquisition and divestiture, or market entry.
All of this helps determine which steps would create the most value. If a turnaround of disappointing segments is not imminent, management can communicate the game plan. The system buys time for the bank.
While high-performance banks will benefit from more disclosure, institutions with weak segments will be exposed and asked to explain why their strategy isn't working. By defining plans in terms of value creation before the fact-rather than as a reaction to poor results-potential damage to investor confidence is minimized.
Still, some chief financial officers are wary about FAS 131 because it limits their ability to manage and smooth earnings across segments-which indeed it does. With EP management systems, value creation becomes the mantra. In the incentive structure, value creation occurs over the long term. Quarter-to-quarter earnings targets become less meaningful.
Another worry expressed by bank CFOs is that FAS 131 puts pressure on short-term performance for lines of business, at the expense of long-term growth. An EP management system helps combat this by providing a way to convey to investors an organization's long-term growth plans in value terms. …