The Profits Premium Paradigm

COMMERCIAL IN CONFIDENCE

GOOD-BYE TO GOODWILL, HELLO PROFITS PREMIUM

How Goodwill is really math, how Staff can really be assets, and why normal Accounting reports make managers cannibalize their own future profits.

(or, more formally)

THE PROFITS PREMIUM PARADIGM

A revision of the nature of ‘Goodwill’ can lead

to modified accounting reports and create new ways

to understand and manage assets, profit and value

Andrew J. Olsen

andrewolsenmail@gmail.com, August 4, 2012

Abstract:

The insight that “Our Staff are our greatest asset” or at least an asset of some kind is contradicted by conventional accounting reports.  Staff do not appear under ‘Assets’ in the Balance Sheet and are purely an expense in the Profit and Loss (P&L).  Firing Staff even improves Net Profit (NP) because it reduces expenses in relation to revenue.  This paradigm does not facilitate an asset management approach to Staff and can even lead them to be seen as a necessary evil. 

These and other inadequacies are traced to a flaw in the way Goodwill is conventionally understood.  ‘Goodwill etc.’ is the premium that buyers of businesses pay for the reputation, brand, customer base, etc. that should keep customers and NP coming in.  It is argued that the term ‘Goodwill’, associated as it is with words like 'reputation', 'intangible', 'subjective', 'estimation', ‘intuition’, etc. obscures the true nature of that premium and renders a rich representation and understanding of that value highly difficult.  An alternative term, the ‘Profits Premium’ (PP), defined as the dollar figure calculated from the anticipated Net Profit of a business over a given period (e.g., three years) set against its estimated probability (the balance of confidence vs. risk) – is offered to both explain and replace ‘Goodwill etc.’ as a more accurate, researchable and useful description of that premium.  It is proposed that all elements of Goodwill/PP (e.g., reputation, brand, buying a customer base, valuation of the staff asset, the potential of future contracts, the likelihood of a healthy Return on Equity (ROE), etc.) are linguistic translations of a single intuited PP mathematical formula.  Confusion about this relationship between language and mathematics limits insight and progress in various aspects of Accounting practice and business management. 

It is further proposed that the dollar value of this promise of future Net Profit called ‘Goodwill’ or ‘PP’ resides in (a) the Customer Profits Premium ($CPP) – the future NP dollar value of the customer base and customer loyalty, (b) the Staff Profits Premium ($SPP) – the future NP dollar value of the skills, systems, tacit wisdom and loyalty of the staff, and (c) the Buyer’s Synergies Profits Premium ($SyPP) - the unique NP dollar promises of a merger/ buy-out/ takeover/ etc. by a particular buyer.  PP and each of these components of PP ($PP = $CPP + $SPP + $BSPP) have exact dollar values: each $PP = anticipated value of $NP/time x probability of same).  A PP Paradigm Balance Sheet is proposed as a way of enhancing a conventional Balance Sheet so that fair value Enterprise Value (EV) is shown as the sum of BV and PP each with their component parts.  A loss-costs method for discerning the relative dollar values of (a) customers vs. staff (CPP:SPP) within PP, and (b) individual staff within SPP is described.  This can be used to develop managers with the PP paradigm but may also have practical and commercial applications.

This PP paradigm (PPP) opens various new perspectives and management opportunities that cannot be seen using the conventional accounting paradigm.  For example, the PPP (1) is able to show a seller/ buyer the full fair value of a business, not just the BV, in accounting terms on an accounting report; (2) renders accessible to reason, psycho-social research and accounting practice the mysterious yet ubiquitous translation of ‘Goodwill etc.’ into dollar figures (including its sub-components and the relationships between them) in terms of mathematical reasoning rather than only as hunches, pitches and expert estimations; (3) solves the riddle of why managers often understand that Staff are their ‘greatest asset’ yet the books show them only as a cost (the solution is that Staff have an exact dollar asset value ($SPP) within the PP and simultaneously an exact but different dollar expense (Salary) in the P&L; thus culling staff to improve NP is also forfeiting a real PP dollar asset); (4) makes it possible to bring greater financial clarity to staffing decisions by attributing realistic, exact dollar asset values to all employees and to each employee uniquely; (5) makes it possible for managers to apply to each and all employees an asset management approach (which could include the appointment of a VP of SPP); (6) is able to show managers how maximizing immediate NP by cutting/ compromising PP assets (like Staff) can jeopardize future NP, and by how much, all in comparable dollar figures; and (7) renders customers and the customer experience subject to a direct asset management approach (which may include the appointment of a VP of CPP).  All this is done through straightforward integration with conventional accounting reports that are easy to understand in known formats and as reality-based dollar figures.  For owners (including shareholders) and managers the PPP leads to greater leverage in various realms, each of which can lead not only to greater NP but also to greater EV. 

That was the Abstract, here is the whole article:

https://www.dropbox.com/s/1l7g94mr152s011/PPP%20Profit%20Premium%20Paradigm%20journal%20article%2030Jul12.doc?dl=0