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How to identify Asset Impairment

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Asset valuation is a topical question (Chapters 4 and 5) and sometimes the business context creates real challenges. The accounting standards give definitions and methods for valuing assets but I use Plain English concepts: book value, willing buyer/willing seller, garage sale and fire sale. 

The concept of 'impairment' is that an asset now has a lower value than the book value - is worth less than what you paid for it (same idea as your brand new car the nanosecond you drive out of the car yard). Chapter 5 of Financial Performance Unveiled works through a landmark example of the implications of a significant difference between book value and 'garage sale'. If you're in charge of the project or business unit, this can be a 'career limiting' experience. 

So let's look at a very different business. 

I was sitting next to an auditor, John, for a long dinner so asked him what he’s audited that was unusual. Turns out he specialises in valuing game parks in South Africa. 

Interesting questions to ask: 

  • what are the assets in a game park?
  • how do you value a game park? …animals? …land? …multiple of average tourism park earnings?

A few years ago, some of the key animals in the country's leading game park were found dead each morning. So the owners organised a para-military team to go in and watch 24/7. Turns out the culprit was the prized asset – the lion that had become cranky in old age – but was the very animal that private clients paid big dollars to see. The owners helicoptered in special meals so that it wasn’t hungry. That didn’t work. They had to …write down the book value of the assets  (in accounting speak).

How you put that story into financial statements? “Easy”, he said. “Given that the project cost $2m - and you can't hide that anywhere - we called it Pest Eradication Program”. That didn’t upset animal lovers and was accepted as a reason for the spike in expenses.


Two issues to consider

Definitions matter

The definition of an asset is an economic resource to generate revenue (and hopefully real profit) in the future. The concept of life cycle  - which proposes that investment must be made to ensure an asset continues to 'perform' - generate revenue - needs to be remembered by all business managers. There won't always be hollow logs...

If you suddenly 'lose' your key assets, your business could be in trouble. At least in a game park business, part of the customer experience, and value, is searching and waiting. No so for 'bricks and mortar' businesses. 

Assets need to keep performing

We are seeing so many companies which have been successful for many years sell off parts of their business deemed to be 'low performing'. Media headlines have trumpeted 'Lazy parents give up their lazy children' and so on. In the 1970's, businesses grew through acquisition of 'complementary' businesses. Conglomerates were considered a good way to spread and minimise risk. Now the opposite view is being put. 

Two questions to ask

1. How can you - in the 2010's - ensure that your mix of assets and businesses continue to generate revenue (and profit)? Thinking about the prize lion as the key asset in the game park, can you see any listed companies putting all resources behind one prize asset (or brand)? With increasing earnings contribution, the risk profile increases. 

2. There are many businesses experiencing structural change. Business will never be the same again. What metrics do you monitor to know if that is happening? 

The interesting aspect about reading financial information is how the numbers look and work for different businesses. Keep reading this blog to hone your commercial acumen.

This blog is for education purposes only.

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