Archives For Current Affairs

On the right track?

aksaroya —  26 November 2012 — Leave a comment

By Peter Williams, Accounting and Business journalist and accountant

As well as highlighting the DfT’s poor record on bidding processes, the West Coast Main Line franchise debacle poses deep questions about the accounting profession’s ability to model risk. 

In May 2011, the Department for Transport (DfT) published a mercifully short document, A Guide to the Railway Franchise Procurement Process, which I read, prompted by the debacle over the West Coast franchise. When all hell broke loose over the flaws in the model, a team of consultants from PwC – previously let go to save money – found the errors in the spreadsheet within half an hour.

The DfT admitted that significant flaws had been discovered in the way the bidding process had been conducted. The risk assessment was messed up as a result of mistakes in the way inflation and passenger numbers were taken into account, and how much money bidders were then asked to guarantee as a result.

The track record on these processes is not good. The Transport Select Committee heard from Virgin boss, Richard Branson, at the beginning of September, weeks before the DfT ditched the franchise process. According to Branson’s evidence, on four recent occasions companies which won bids subsequently admitted to several financial difficulties or went bust.

You may think that the Department may be scarred by those experiences by now. We all need to be sceptical of forecasts that predict high growth right at the end of the period. And to be fair to the civil servants, that May 2011 guide is clear the biggest money bid won’t win unless everything else appears in order. The Department promises it will assess the cost and revenues set out in bids. If this assessment indicates a significant risk that costs of revenues will not be delivered or identifies other reasons why the franchise is likely to be financially unstable, the Department can rule out those bids from the competition on the grounds that they are financially high risk.

Aside from all the clever technical and academic input to investment appraisal, it boils down to one technical question: would I rather receive some money from that person now or much more in five years time? If you cannot see from a common-sense perspective where those big numbers are coming from, then perhaps it is time to say thanks, but no thanks.

The West Coast example should raise some awkward questions for how good accountants are at creating and understanding these models. They are in a good position to do the number crunching, but in building models what are their drivers? What pressures do they face in stressful commercial situations? They need to take a more independent, strategic position on the risk and reward that governments should ask for and private companies should be prepared to shoulder.

Maybe competent and honest professional accountants have become too wedded to the all-pervading efficacy of spreadsheets. As well as quantifiable risk which can be modelled, the accountancy profession needs to start looking at the impact of human psychology and behaviour in difficult and complex accounting and business contexts. We need to ask ourselves questions which we have barely started to think about: if we want to achieve a certain commercial result, how does that impact on the way we behave?

This post first appeared in Accounting and Business UK November 2012.


by Emmanouil Schizas, senior policy adviser, ACCA

For a project billed as the antidote to Big Government, the Big Society has an impressive number of civil servants working on it. At ACCA, we are used to staff from the UK Department for Business, Innovation and Skills (BIS) and other departments calling to discuss government initiatives but, even by these standards, the drive to operationalise the Big Society is intense.

The general narrative appears to be this: the government can no longer afford to pay for public services to the extent that they used to, therefore communities and businesses will have to be encouraged and enabled to take up the funding and/or management of some of these services. Overall, the supply of public services should recover quickly or even remain unchanged in the face of cuts in the public sector.

Last year, a major survey for the World Economic Forum confirmed that SMEs are seen by more people around the world as 'values-driven' than governments, big businesses or the institutions of global governance. Although the UK was not surveyed, it's probably fair to say that the UK public and policymakers largely share this view. Hence, the expectation that smaller businesses, which presumably care more about their local communities than faceless bureaucracies in the private or public sectors, can help make the Big Society a reality.
In a rare large survey of SMEs on the subject run by Touch Local, 43% claimed to understand what the Big Society represents, although as their comments indicated, their understanding implies neither engagement nor approval. Happily, we have an indirect way of gauging small businesses' taste for the Big Society, as the UK Citizenship Survey asks the self-employed and staff in small businesses about what they do, or would like to do, for their local communities. Ironically, fieldwork for the last-ever edition of the UK Citizenship Survey will be completed this month, after which the whole thing will be scrapped.

What the 2008/9 Citizenship survey (the latest whose data are freely accessible) found was that the self-employed gave twice as much to charity and spent on average 16% more time in civic participation, as well as 26% more time volunteering, than employees did. Moreover, when they do get involved, the self-employed seem to have more success improving local services. That said, no self-employed person was able to put more than six hours a day into this type of work, and their typical contribution was closer to three hours a month.

If the bosses can only help so much, could they perhaps assist their staff who want to do more? The quick answer is not really. Engaging the community in such a way requires resources that small businesses don't have. Only about one in six (16%) employees in businesses with fewer than 25 staff said their employer had a scheme in place for helping out in the community. The smaller the business, the less likely it is to have such a scheme, and the more likely it is to support only giving and helping programmes related to its commercial business. On the other hand, staff in small businesses were more likely to participate in these schemes where they existed: 39% were involved in helping out in the community, against 25% in large businesses (those with 500+ staff).

There is other good news, of course. Not everyone goes into business to change the world, but about a quarter of new UK entrepreneurs do set out to meet social objectives in addition to, or instead of, financial ones. Data from the Global Entrepreneurship Monitor (GEM) suggests that around 2% of the UK's adult population (more than 800,000 people) were involved in early stage social entrepreneurial activity in 2009. The GEM data also offers some hope that the appetite for this should persist once the cuts have taken hold: in 2009 social entrepreneurship was thriving in the US, traditionally seen as a small-state country, as well as the more enlightened but recently bankrupt country that is Iceland.

However, there is a catch: the GEM data also shows that most social enterprise activity in the UK is not attached to an earned-income strategy (see table), but is funded wholesale by either charitable giving or the state. The latter is problematic because it means that the Big Society will have to compensate for the scaling back of social enterprise activity bankrolled by the state as well as local government services. A recent review by the independent fact-checking website FullFact found that although very small charities tend to rely mostly on private funding, the larger ones tend to be much more dependent on the public purse.

Hence, the scepticism expressed by many small business owners when asked in a recent small survey whether they thought social enterprises would benefit from the retrenchment of public service provision.

All of the above suggests that the mechanics of the Big Society are at odds with the reassuringly tribal image of 'people pulling together' that is often invoked by the government. What is becoming operationalised as the Big Society requires people and organisations to assume liability, to manage budgets and to employ staff.

Inevitably, the expertise in all of these areas does not lie with kind-hearted neighbours 'helping when they can' but with organisations that are established and well-resourced or single-mindedly mission-driven, or both.

Project Merlin

accawebmaster —  31 January 2011 — Leave a comment

By Emmanouil Schizas, senior policy adviser, ACCA

Upon returning from annual leave, I was not overly surprised to find that the UK government was in a spot of trouble with its latest initiative in support of small and medium-sized enterprises (SMEs).

The initiative in question is named 'Project Merlin', although 'Loans for Bonuses' might be more appropriate. The deal is that banks will be allowed to set aside slightly more funds for their bonus pots or avoid further windfall taxes if they also commit to lend more to SMEs. This is of course mostly conjecture as no one is very happy to discuss what the banks are getting in return in this deal.

This isn't the first time since the Lehman collapse that small business lending targets have been discussed, or even imposed, in the UK. Invariably, previous attempts have failed (see here, here and here). It should come as no surprise then that Project Merlin has now stalled, although enough political capital has gone into it to animate it for a while.

Why the banks and the government will never strike a credible deal…

One problem with lending commitments is that neither side has a real incentive to honour their obligations. No government can fully commit to a soft(er) touch on banks, whether in words or deeds, unless the opposition and media also sign up to the deal; such a commitment would be political suicide. As the past three years have shown, governments will always reserve the options of windfall taxes, regulation and even nationalisation.

Meanwhile, no bank with shareholders to answer to can commit publicly to either lending on non-commercial terms, lending at a loss, or lending without regard to risk.

If you do hear of a deal to save Project Merlin, take the news with a pinch of salt – the wiggle room involved for both sides will be enormous.

… and why they shouldn't anyway.

But planning commitments aren't just unreliable, they are completed misguided. If bonuses really do encourage reckless risk-taking on a systemic level (and they have in some cases), extra lending to SMEs will not offset this; in fact, if the extra lending is performed on less than commercial terms it will make bonuses even riskier as banks' capital will be depleted.

More to the point, central planning doesn't magically become workable when the private sector jumps on board. Banks (whether individually or collectively) cannot guess the demand for loans in the current environment any better than the government or anyone else with an econometric software licence (evidence here); nor do they understand the strength (or otherwise) of the aggregate small business balance sheet.

Who is to say that £70bn (the amount supposedly pledged by banks for small business in the latest round of negotiations) is a sustainable amount to lend to UK small businesses at this moment? It is, after all, 31% more than the current amount of credit outstanding. Or is it, as one can't help but suspect, a figure plucked out of the air, like Homer Simpson's Tomacco valuation?

These are substantial risks and UK taxpayers – who own a good deal of the UK banking sector and of whom 60% work for SMEs – need to be very mindful of what is signed on their behalf; they will be exposed to SME default risk on both sides.

To their credit, the technically-minded people in both banking and the government admit that they don't have a proper birds'-eye view of the SME sector's finances, which is why the banks are about to spend millions per year on the biggest-ever series of regular surveys on SMEs' access to finance (a Banking Taskforce recommendation) in order to find out more. ACCA is represented at the meetings of the technical group working on the study's specifications and we understand it will be some time before this produces any actionable information.

Now suppose the plan goes ahead and SMEs fail to develop an appetite for the credit bonanza bestowed on them. Maybe they're afraid of a double-dip, they want to be debt-free, or they no longer trust banks. Perhaps banks will then be forced to honour their obligations by lending to anyone so desperate for cash right now that they don't care whether they'll be able to pay it back. Is this a real risk? Yes it is.

As our joint research with the Confederation of British Industry (CBI) found last year, the chances of an SME with poor cash flow applying for short-term credit are roughly twice those of an SME with strong cash flow.

More realistically, banks will return to business as usual but try to increase lending where it is easiest and safest to do so. We know from our international research with Forbes that lenders hate it when their loans are used to finance SMEs' customers (essentially they avoid borrowers with poor cashflow, a finding confirmed by the CBI research) and international research shows that they are increasingly cautious of unsecured lending. So this extra lending will go to the largest and safest businesses, and particularly those with very reliable customers, such as the government.

Arguably, these are the businesses that least need the government's help.


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