La Bourse / Volume III / Nº III.07 / Workbook — the executive

A woman reading a book by a curtained window, her face turned down to the page, soft morning light. — Plate III.07 · Workbook — the executiveThe Core on the Open Page.One of these two objects is audited and one of them is true, and the work of this chapter is to stop that being two different sentences.

WORKBOOK — THE CORPORATE EXECUTIVE

Chapter III.07 · The Regenerative Balance Sheet

For the person with a P&L, a facility agreement, an audit committee and a quarter. This workbook uses the language of the firm without apology, because the firm's own documents already contain most of what follows — they have simply never been arranged to show it.

THE PREMISE, STATED COMMERCIALLY

You hold assets whose productive capacity is rising and whose carrying value is falling, on a schedule, by convention. That is not a philosophical complaint. It is a measurable distortion with three consequences you can act on this quarter:

Reported margin is wrong in a direction you can name. On one illustrative wood the same year's growth is plus £21,681 under IAS 41 and minus £29,000 under the cost model — a £50,681 swing, 15.4 percent of operating profit.
Your covenants do not see what you think they see. A restatement lifting operating profit 37.8 percent moves net debt to EBITDA from 3.92 times to 3.92 times.
Somebody else is already valuing these assets at market, annually, and charging you for the consequences — your lender's valuer, your insurer, and in the end the revenue authority.

The work is to bring those three into one document before somebody else brings you the third one.

PART ONE — THE SWEEP

Weeks 1–3

Exercise 1.1 — The routing sheet (one afternoon with your controller)

Take the fixed asset register and the balance sheet and run every material line through four questions, in order.

#	Question	If no
1	Does it regenerate without us?	Out of scope. Stop. Most of the register is here.
2	Can our decisions change the rate?	Disclose the dependency and its trend. Stop.
3	Observable market for it as it stands today?	Physical schedule only. Money column £0.
4	Already measured by somebody, for another reason?	You have found your cost problem.

Output: one page. Every £0 carries a one-sentence justification. That sentence is what survives the challenge; a blank row does not.

Exercise 1.2 — The four documents you already pay for (one week)

Ask for these and read them yourself. Do not delegate this; the value is in seeing them side by side.

The lender's most recent security valuation. Market value, dated, signed. Compare it with the carrying value in your own accounts. On the illustrative farm that comparison is £11,280,000 against £2,640,000 — 4.27 times.
The insurance schedule. Reinstatement and stock values, annually restated.
Any regulatory or agronomic condition survey. Somebody is already counting.
The definitions section of your facility agreement. Specifically Consolidated EBITDA. Find out whether unrealised fair value movements are excluded. They almost certainly are.

Exercise 1.3 — The gap statement (90 minutes)

One page for the audit committee: for each material living stock, the carrying value, the best external market indication, the date of that indication, and its source. No recommendation. No conclusion. The gap is the finding, and a page with no recommendation on it is read more carefully than a page with one.

PART TWO — THE ARITHMETIC ON YOUR OWN NUMBERS

Weeks 4–7

Exercise 2.1 — Restate one stock, properly (two weeks)

Choose the largest and best-measured. Then, in this order:

Fix the unit and freeze the definition in writing, with a date. Cubic metres at a stated top diameter. Head at a stated age class. Tonnes of carbon at a stated depth and bulk density — 30 centimetres and 1.30 on the illustrative farm, written into the definition, because a soil figure without a depth is not a figure.
Value it, less costs to sell. The deduction is compulsory and it is also your best defence: £481,576 gross becomes £457,497 after 5 percent, and nobody can say you presented gross.
Compute the uplift and the deferred tax separately. On the illustrative farm the uplift is £425,817 and the deferred tax £37,080 — 8.7 percent, because commercial woodland is outside the charge and creates no taxable temporary difference while the herd does.

Exercise 2.2 — Run the covenant model both ways (one day)

Build the covenant pack on the restated basis and on the filed basis, side by side, for every covenant in the agreement.

  interest cover, PBIT basis, >= 2.50 x     filed 2.32 x BREACH   restated 3.20 x
  net debt / EBITDA,          <= 4.00 x     filed 3.92 x          restated 3.92 x
  tangible net worth,   >= £ 2,000,000      filed £2,990,000      restated £3,378,737

Then run the downside before you run the upside, and present it first. Hold volumes constant — 971 cubic metres grown, 300 removed, 14,835 standing — and move the price to 75 percent. Minus £98,113 through profit and loss, operating profit £334,887, cover 2.36 times against a 2.50 times covenant. A breach caused by a price index, with no cash movement.

Exercise 2.3 — Price the exposure before anybody prices it for you (half a day)

  base audit fee                                    £  42,000
  significant-risk Level 3 uplift, 43 %             £  18,060
  independent valuations, annual                    £  20,000
  frozen-GAAP side letter over five years           £   1,600
  TOTAL ANNUAL COST                                 £  39,660

  against a 35bp step-down on £2,450,000            £   8,575
  NET                                               £ -31,085   cover 0.22 x
  breakeven debt                                    £11,331,429

Put that table in your own paper, on page one. On the financing argument alone, an enterprise below roughly £11.3m of debt should not do this, and saying so is what makes the rest of your paper credible. A proposal that cannot state the size below which it fails has not been costed.

Exercise 2.4 — Find the argument that does pay (one week)

Three counterparties, three mechanisms, and only one of them is the lending argument you started with.

The revenue authority. On the illustrative farm the succession charge is £2,491,163 — 83.3 percent of book equity — because relief is 100 percent on the first £1,000,000 and 50 percent above it against relievable property of £13,455,817. Ten interest-free instalments of £249,116, covered 1.30 times by cash of £323,000, with headroom of £73,884. That exposure exists whether or not you restate. The restatement is the only document that shows it ten years early.
The insurer. A verified standing stock is an underwriting input, and a premium reduction is the same money with less documentation.
The marginal-cost test. The valuation you need for the tax return is already being commissioned. Cover on the gross cost of £20,000 is 0.81 times; on the marginal cost of £7,500 it is 2.16 times. Same evidence, same year, different question.

PART THREE — THE BOARD PAPER

Weeks 8–12

Exercise 3.1 — Write it in this order (one week)

Six sections, and the order is the argument.

What is standing. The physical account, four columns, one page.
What it is worth, and what that valuation did not look at. The gap statement from Exercise 1.3, now with a number on it.
What it costs to carry. The £39,660 and the £11,331,429 threshold, before any benefit is claimed.
What moves and what does not. The covenant table, both bases, downside first.
The exposure that is already there. The succession or disposal charge, computed on market value, set against book equity.
The ask. One decision, one signature, one number.

Exercise 3.2 — The three conversations, in this sequence (four weeks)

The auditor, first and in writing. Ask about measurement reliability and useful economic life. These are conversations they have every year and are good at. Ask before the year end, not during it, and ask in a meeting you called.

The lender, second. Ask for a frozen-GAAP clause — covenants tested on the accounting basis in force at signing. About £8,000 of legal time and the cheapest protection in this entire subject. Ask for it whether or not you adopt fair value; it costs the lender nothing today and it removes a whole category of future argument.

The audit committee, last. By then you are reporting a position rather than proposing one, and you have the auditor's view and the lender's clause in hand.

Exercise 3.3 — Decide what you will not do (two hours)

Write down, before anybody asks, the three things you are declining:

No money figure where there is no observable market. The soil column reads £0 and stays there, and the tonnes column — 631 tonnes of carbon a year on the illustrative farm — does the work instead.
No fair value movement in a remuneration formula. Revaluation informs financing; physical quantities inform pay. Tonnes cannot be revalued by an assumption, and the moment an uplift feeds a bonus the assumptions acquire a direction.
No migration to the sustainability report. The schedule stays beside the management accounts, in the same typeface, with the same footing discipline, or it does not exist.

Declining three things in writing is what makes the fourth thing believable.

WHERE YOUR OWN NUMBERS ALREADY SUPPORT THIS

Four places, in most firms, and none of them needs a new system.

The fixed asset register. Items at or near zero book value still in production. Each is somebody's judgement that the schedule was wrong, and the register is a list of them.

The disposal gains line. A large gain on disposal is usually a measurement error being paid out in one period. Pull three years and look at the ratio of gain to proceeds.

The security valuation file. Already market, already annual, already signed by somebody with professional indemnity cover.

The insurance schedule. Already restated, already external, already paid for.

You are not asking the firm to believe anything new. You are asking it to put four documents it already commissions on the same page, and to notice that three of them disagree with the fourth in a consistent direction.

THE FOUR OBJECTIONS, AND WHAT TO SAY

Every one of these will be raised, usually in this order, and each has a short answer that is also true. Rehearse them; the paper is won or lost in the eight minutes of questions after it.

"This is aggressive accounting." It is the opposite, and the arithmetic says so. The valuation is struck less costs to sell — £481,576 becomes £457,497 — and the deferred tax is recognised in the same motion. Meanwhile the convention you are being asked to keep recognises a deferred tax liability of £2,160,000 at full undiscounted face on a disposal nobody intends to make, when its present value at the firm's own borrowing cost over the expected holding period is £527,609. One of the two treatments is asymmetric and it is not yours.

"The auditors will never accept it." They have accepted it since 2003. IAS 41 requires fair value less costs to sell for biological assets and puts the change through profit or loss. The question you are actually asking your auditor is a measurement-reliability question and a useful-economic-life question, and those are conversations they have every year. Ask early, in writing, in a meeting you called, and ask before the year end rather than during it.

"It adds volatility we do not need." Correct, and you have already priced it: £39,660 a year of assurance cost, and a downside case in which a 25 percent price fall puts minus £98,113 through profit or loss and takes cover to 2.36 times against a 2.50 times covenant. That is why the frozen-GAAP clause is in the recommendation and why it is asked for first. An enterprise that adopts fair value before it has that clause has bought the downside and not yet bought the defence.

"What problem does this actually solve?" The best question and the one to answer last, because it is the one with a number. The exposure already exists, assessed on market value, while the accounts show cost. On the illustrative farm the charge is £2,491,163 against book equity of £2,990,000 — 83.3 percent — and it arrives as ten instalments of £249,116 covered 1.30 times by cash of £323,000. Nothing in the restatement creates that. The restatement is the document that makes it visible while there is still time to fund it, and the alternative is finding out in the year it falls due.

One tactical note on sequence. Do not lead with the growth. Lead with the gap between the security valuation you already commission and the carrying value you already file — on the illustrative farm, £11,280,000 against £2,640,000, or 4.27 times. That gap is somebody else's number, signed by somebody else, and it puts the whole discussion on ground you did not choose. By the time you reach the growth figures the room has already conceded the principle, because it conceded it years ago when it accepted the valuation.

SELF-ASSESSMENT

One. Can you state, from memory, which of your covenants would move under a restatement and which would not — and quote the definition that decides it?

Two. Have you priced the exposure before the benefit, in your own paper, on page one?

Three. Can you name the counterparty for whom this restatement is worth more than it costs, and prove it with a breakeven rather than a projection?

Four. Is there a £0 in your money column that you can defend in one sentence to a hostile reader?

Five. Does your downside case hold volumes constant while moving price — and does your paper present it before the upside?

Six. Have you asked the auditor first, in writing, in a meeting you called?

Six yeses and this is a position, not a proposal. Five and it is a good draft. Fewer, and the missing one is almost always the third, because the lending argument is the one everybody reaches for and it is the one that fails first.

A last note on timing. Start this in the first quarter of a financial year, never the last. The count needs a clean opening position, the auditor needs the conversation before the year end rather than during it, and the lender's appetite for an amendment is highest when nothing is being asked of them urgently. A restatement begun in month eleven becomes a year-end argument, and a year-end argument is the one environment in which every party defaults to the convention they already know.