The article talks about how
different financial statements do not matter to digital companies as compared
to industrial firm and also the impacts of this financial statements. The main
purpose is to determine the impact of financial statements to the valuation and
profitability of a digital company. It looks at digital companies such as Uber
and Twitter which had reported losses in their financial statements, yet they
commanded a very high valuation in their IPO. Other digital companies which had
never made any profits or had been making losses such as LinkedIn and WhatsApp
were bought for $26 billion and $19 billion by Microsoft and Facebook
respectively. This is in contrast to what happens in industrial firms. For
example, Industrial giant GE which had never made a loss in 50 years had its
stock price decreased by 44% after making its first loss.
The article also quotes the
2016 book titled the End of Accounting written by Baruch Lev who claimed that
over the last 100 years financial reports have become less useful in capital
market decisions. This is especially the case with for digital companies
whereby the income statement and balance sheet have little salience and do not
give a reflection on the true status of the company. For example, when it comes
to the balance sheet, the assets reported have to be physical in nature, owned
by the company and within the confines of the company. This is not the case
with digital companies who mostly offer services as opposed to having
inventories. For example, Uber is the largest taxi company in the world yet it
physical owns zero taxis as inventory. Contrasting digital and industrial
companies in the same one can see a difference. For example, Walmart has $160
billion in hard assets and is valued at $300 billion compared to Facebook
valued at $500 billion with hard assets totaling $9 billion only.
The article final finding is
that intangible assets have surpassed property, plant, and equipment in the
modern world. In ancient accounting methods, the more an item is used, the less
valuable it becomes- this is the opposite with digital services which actually
appreciate more instead of depreciating.
The concept of network effects, or the increase in the value of a
resource with its use is not an accounting concept catered for in financial
reporting. Digital companies are becoming more prominent in the economy while
traditional industrial companies are becoming more digital in their operations.
The building block for the modern company is research and development, brands,
organizational strategy, peer and supplier networks, customer and social
relationships, computerized data and software, and human capital (Govindarajan,
Rajgopal, & Srivastava, 2018). This shows that the more a digital company
invests in building its future, the more losses it will report.
The article also looks at
modern development in the industry whereby financial reporting is done as more
of a requirement as compared to it being a reflection of the financial status.
Another development is the use of stock bonuses in CEO compensation plans as
compared to cash-based bonus as the need to invest in long-term profitable
intangible assets compared to short-term profits. As much as profitability is
not important in digital companies, it is important to note that a profit
mostly indicates an end to the investment face. It is unlikely that the
accounting standards will change to accommodate for digital companies, however
they can still improve on their financial status by reporting on items such as
cues about the success of a company’s business model, such as acquisition of
major customers, introduction of new products and services, technology,
marketing, and distribution alliances, new subscriber counts, revenue per subscriber
numbers, customer dropouts, and geographical distribution of customers
(Govindarajan, Rajgopal, & Srivastava, 2018).
Conclusion
With the increase internet
access, speeds, and other services, digital companies will continue to play a
vital role in our lives. The article raises key questions about how we do our
accounting and whether it is the right way or do we know to change it. The key
question is whether it is fair to account for digital companies the same way we
do for industrial companies and whether the valuation gives a fair result. With
investors ignoring the traditional valuations and still investing in companies
making losses as per financial statements maybe it is time for a change.
In my opinion, the article
is absolutely right. Nowadays, almost everything that we do in our day to day
lives involves the aid of a digital service. At a personal level, we value this
services according to how much and often we use them, however, when it comes to
reporting them, it’s an injustice. The traditional accounting methods
concentrate more the physical assets that belong to a company whereas digital
company operates virtually and its major assets are intangible. Besides,
digital companies work differently as the most important element is networking
and research and development which is not catered for in the current accounting
system. I believe we need to develop new accounting standards and practice to
be used in the valuation of digital firms. This will not only affect digital
firms, but all the companies in general as all companies use an element of
digital services in their operations. Failure to do this will make the
traditional financial statements just a routine with absolute influence on
investors as the information will become less and less important.
References
Govindarajan, V., Rajgopal, S., & Srivastava, A.
(2018, February 26). Havard Business Review. Retrieved March 1, 2018,
from Havard Business Review Website: https://hbr.org/2018/02/why-financial-statements-dont-work-for-digital-companies
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