Fixed Investments — Beyond the Balance Sheet
The fact is that one of the earliest lessons I learned in business was that balance sheets and income statements are fiction, cash flow is reality.
Fixed Investments refer to physical assets such as buildings, land, machinery not destroyed or consumed during the production of a good or service. Any college business major can point to the balance sheet and identify the fixed assets of a company. Ask that same business major how the fixed asset number ties to revenue and the answers are not so clear.
The Problem
Try to gain revenue for a room-night at a hotel without a hotel room, or try to sell a cup of coffee without a coffee machine and you will have instant hostile customers. It seems absurd to even think like this, yet most businesses treat their fixed investments as an unwanted nuisance kept locked away and forgotten. As long as the fixed asset is behind the scenes doing the work, don’t worry about it. Unfortunately, this neglect soon catches up with the business and large amounts of precious capital are required to get the operations back on track.
This attitude, in part, assisted in driving the world markets towards the crashes and recession that ensued. As long as a fixed asset amount showed up on the balance sheet, that was all the accounting that was required. Who cared if the asset was at risk of failure or that the actual life expectancy and the booked service life did not agree. The investment bankers only needed to see these asset amounts to provide a valuation in order to ratchet the debt up according to a preset leverage parameter. If the business didn’t exceed a certain leverage point, the rating was still investment grade. In actuality, these pencil-whipped balance sheets became the paper foundation that toppled Wall Street.
The Solution
The key to every business is cash flow. We make decisions every day to increase cash flow or at least to not jeopardize it. These decisions need to be based upon having most if not all of the pertinent information at hand. Several helpful asset indicators need to be gauged such as risk to revenue, efficiency, and expected useful life remaining in order to make true cash flow decisions.
Assets are almost never really fixed — there is a consumable aspect to machinery and property. Through normal production, there is a lessening of the useful life expectancy; through misuse, there is a much greater loss of useful life expectancy. How much use or misuse and what maintenance has been performed to keep these assets in shape speaks directly to the risk to revenue. This is much more effective than a straight-line depreciation clock that may undershoot or overshoot the life expectancy targets. It is also interesting how the efficiency of an asset such as an air conditioning chiller and risk of failure go hand in hand. The correlation comes into play when logs can show metrics over time. If a sharp drop off in efficiency occurs, you can pretty much count on failure in the near future.
We as business and finance directors must change our way of looking at reports and figures. There is always a story behind the numbers that is seldom tracked. This is one of our main goals at ROI Reports — education and discussion so we can change the traditional business operations model. Follow us for a weekly update offering unique insights into the world of business, finance, and operations. We welcome your feedback and suggestions. Remember: “Lack of money is the root of all evil.”
Originally published at roireports.com.
