Financial analysis of financial public statement

[Yves]

Dear all,

As an ex-Crédit Suisse private banker and private financial analyst, I have recently (2006) entered PFM expert world. This gave me the opportunity to have a private look to public finance.

Not mentionning the privilege to work with Mauro during an exciting 2009 Cairo MTEF assignment, I met Alain-Gérard Cohen in Rabat last year and I told him about the unsatisfaction I felt concerning traditional analysis of budget "soutenabilité" and concerning the lack of true transparency of public finance compared to what is available in private sector.
After long off-work discussions in Rabat, we decided to try together to go through an analysis of public finance using private sector tools, as if we were Crédit Suisse executives bankers or private investors evaluating the risk of investing in a kind of holding that name would be "France", ou "Germany" or any other state, as if it was a private company working in a competitive sector.

The article we wrote propose an essay of private analysis of public finance and a set of new indicators we consider more relevant for a fair and true evaluation of public finnace financial situation.

You will find then this article here joined written in French.

[Napodano]

Dear Yves,

Thank you. This is major and generous contribution from your side.
Most of the PFM reforms are imported from private sector applications, so your perspective is definitively significant.

[Yves]

Thanks Mauro,

In fact you could understand the frustation and even anger of a private analyst used to international standards and logic of private accoutants or financial auditors when he tries to understand for example the financial situation of a town like Tarbes, in French Pyrénées. Like almost all other towns or local authorities, that claim for budget transparency, Tarbes send to its citizen the budget pie-chart presentation you can see page 5 of our article, with colors and beautiful "camembert". What would you say when you notice that new loans are declared as... revenues, and loan repayment as expenses? 

More seriously, if real efforts were done for transparency according to open budget criteria, and especially accrual and patrimonial accountability (chapter I - availability of public finance figures), how for example a private analyst could work out EUROSTAT or French INSEE figures (page 6 to to go through a private standardised method of financial analysis, like he would have done with Renault, ASF (Autoroute du Sud de la France) or IBM financial statements (page 14 to 16)?

Our article present (Chapter II) a quick recall of international standard of private analyst process, analysing balance sheet situation (short and long term of financial balance and stability, working capital analysis, debt ratio) and profit and loss account (EBIT, EBITDA...)

Chapter III is dedicated to a proposition to adapt private sector financial analysis method to public sector: 3.1 budget analysis (profit and loss account); and chapter 3.2 balance sheet analysis (patrimonial approach) and cash flow statement

The main findings summurized in chapter IV are, in our opinion, very important as they clarify the financial situation of public finance and strengthen understanding and  readability of public financial management, as we can see with the example of French 2009 statement analysis (page 61)

Best
Yves

[John Short]

Perhaps this is a critique of the French system - in the presentation of PE that I am used to, loans and loan repayments are below the line as financing items and only interest payments are above the line.  We might be comparing apples and pears when we introduce profit and loss accounts to the public sector.  I will leave that to the accountants and the financial analysts.

 I must confess that my French language skills are not up to the paper itself.

On a less serious note, maybe Tarbes municipality reflects the status of its ProD2 rugby team rather than a Top 14 one and is in need of some serious coaching in the Finance Department.

[atseacliff]

I'm guessing that the authors of this piece would find themselves nodding in agreement to this excellent recent blog by Ian Ball of IFAC on the IMF PFM Blog http://blog-pfm.imf.org/pfmblog/2012/02/accrual-accounting-essential-for-government-transparency-and-accountability.html.  My own view, prior to this article was that  IFAC put too little effort in extolling the virtues of accrual accounting beyond the traditional technocratic viewpoints which most will be  familiar with.  This article lifts the lid on the structure of incentives faced by politicians which encourages them keen to avoid transparency, and putting in place institutional arrangements which are effective in enforcing this transparency to be put in place. Mr Ball does not shy away from the resources required in putting accrual accounting systems in place but argues that there is no excuse for developed countries. As he points out "Imagine a listed entity going to its regulator and explaining that while they were keen to meet the financial reporting requirements, they did not have the resources to operate such a sophisticated accounting system".

In the era of the sovereign debt crisis it is good finally to see IFAC on the front foot.

[Yves]

I am glad to see that Tarbes is not completely unknown! And furthermore, as I am living there, I know rugby is definitly more important than finance.
But my example was just to show or illustrate the opinion of Tarbes bankers: under cover of transparency, public economists, public accountants work sometime hand in hand with politician to keep some opacity which is finally the politician "marge de maoeuvre".
Nevertheless, the aim of the article is to suggest that a quick and better understanding of public financial situation (that would be a part of real transparency aimed to reach a larger public than the few experts or public economists) could be reach easily if countries adopt a standardised presentation close to what is requested in private sector.

But more than the image we can have of financial balances of public accounts, our opinion is that a fair view of public performance should need some structural changements of statements and review of indicators.

We begin, in our article (chapter 3.1), to review public financial Income statement. In private sector, investments are considered as a long term expenses and are then definitly excluded of the operational and financing result which is the result on a yearly basis. To give a fair idea of the annual result, investments should be than extracted from Income statement as it will be a part of cash flow statement (chapter 3.2). Investments cannot be considered as an annual expenses. It is the tool of production of public services and not operational expenses.

Here, we introduce RAP (Résultat de l'Activité Publique) or PAR (Public Activities Result) for our English spoken friends. PAR is public EBIT, Earnings before Interest and Taxes (and investments)

[petagny]

The arguments for improving public sector accounting by reference to private sector standards have much to recommend them, but I'd like to introduce some balancing thoughts.

The private sector is interested in both solvency and liquidity, and we do not want to lose sight of the liquidity constraint in the public sector: in the investment example, if you build a euro 100 million road this year then the cash has to be found to pay for it this year, even though services will be delivered over 20 years or so. Other things being equal, this will increase the deficit or erode the surplus (with implications for the debt stock) which is an important piece of information for government and the public. So budgets, reporting and accounts need to look at the public finances from multiple perspectives. Incidentally, from an economic perspective (micro and macro), it is also important to consider the road as a current year expenditure: from a macro perspective the impact on demand is now; from a micro perspective, the resources used in the construction of the road are used now, are gone forever and cannot be used for anything else (an important piece of information in assessing the value for money of the investment and comparing costs now with benefits in the future).

Let us also not forget that, except for the case of Greece (which is something of an outlier), current fiscal difficulties emanate largely from private sector accounting and governance failures (exacerbated in the case of the eurozone by a one-size-fits-all monetary policy): governments have been obliged to nationalise private sector losses in order to save too-big-to-fail banks and have also suffered on the revenue side from the resulting  collapse in confidence. Now, one might say that this all resulted from regulatory failure on government side, but this is not really the same issue as public sector accounting standards. There are undoubtedly some longer term issues of fiscal sustainability (aging populations, increasing entitlements,etc.) that have been exposed by the crisis and that needed to be dealt with, but certainly not with the speed and vigour of current austerity programmes, and certainly not in the middle of a slump in aggregate demand.

[Napodano]

petagny,

your points are correct but you should enter in the equation the concept of stock, referring to debt. On this account you will find that Greece is in good company with other EU countries.

I agree that the deterioration of debt stock in UK might have come from the private sector failure,  but in countries like Portugal, Italy, and Spain and Belgium (on a lesser extent) the debt stock has remained unchanged at too high levels for too long. These countries did not have the fiscal space to be resilient during the crisis.

[petagny]

At the risk of deviating somewhat from the issue of public sector accounting, the figures show debt-GDP ratios declining in Spain, Italy, Ireland, Belgium from 1995-2007. In Italy the ratio fell from 120% to 103%, still high, but a reasonably significant decline. Spain and Ireland remained well below the Mastricht ceiling of 60%, which was, however, exceeded by both Germany and France in 2007. Over the 1995-2007 period, Germany's debt-GDP ratio increased from 56% to 65% and France's from 56% to 64% (figures from Google Public Data with Eurostat given as a source). Admittedly, Portugal has been on a rising trend, from 48% to 68%, but still well below Greek levels.

With hindsight, most countries would probably prefer now to have been in a better fiscal position at the beginning of the crisis than they were, but a mass effort to redress the position is at best a dangerous distraction from the real problem of global and eurozone macroeconomic imbalances and at worst risks deepening and extending the problem. This is the territory where economics and accountancy probably part company.

[Napodano]

You got me on this, petagny  . Well said!

[atseacliff]

We do seem to be going a little off at a tangent but I guess there is nothing wrong with that.

Petageny rightly points out some important differences between the principles which underlie the public and private sector.  Let us not assume that private sector accounting is perfect.  One of my favorite quotes from Sir David Tweedie (and there are many), the Chair of the IASB was that one of his great ambitions before he died was to fly on an aircraft that on an airline’s balance sheet!

 

[PSCANDIZZO]

I am sorry to join this discussion late, but I was travelling and did not have the time untill now to read the material and collect my thoughts. I agree that some form of economic accrual accounting should be used for the public sector, specially for the balance sheet, but several problems should be considered.

First, accounting and the budget are tools of economic planning for individual firms, while they are instruments of fiscal accountability for the government. Other instruments of economic planning are used by the public sector, such as cost benefit analysis, social accounting matrices, input output and various forms of national and local accounts. Socialist regimes  tended to confuse fiscal responsibility with economic planning with ominous results.

Second, economic aggregates are not necessarily reducible to their  disaggregated components.   Aggregate investment , in particular, is a form of consumption of instrumental goods (machines),  industrial intermediates, raw materials  and labour and contributes both to total cost and to aggregate demand in the short run, while it "may" add to production capacity in the long run. From the point of view of an individual firm, instead, investment is a commitment of resources in the hope of future benefits, so that its relevance for the construction period is only in terms of cost. 

There have been various attempts at incorporating these characteristics in the government accounts. Buiter, for example , proposes to exclude investment from the estimate of deficits and debt sutainability. However, while for the firm the solution is simple : in the income statement (but not in the cash flow statement) annualize the investment according to an acceptable accounting rule, this is not so for the government, which faces the  financial cash flow nature of its accounts (because of their fiscal accountability purpose).  In program and project evaluation, on the other hand, discounted cash flow methods already take into account the different nature of investment as an activity of resource transfer over time.

[petagny]

Apologies for riding away on my favoured hobby horse of the moment, but I think PSCANDIZZO has brought us back on track by raising some interesting points about differences between private and public sector accounting. On his first point though, isn't there also a governance/accountability dimension - with respect to shareholders and lenders - to private sector accounting as well?

[petagny]

atseacliff refers to Ian Ball's post on the IMF PFM Blog setting out the benefits of accrual accounting for the public sector, but support is not universal as indicated by Andy Wynne's response to this post. Andy Wynne has long been against the adoption of private sector accounting approaches in the public sector, but he is not alone in voicing concerns. A few weeks before Ian Ball's post there was another post on the IMF Blog referring to a 2010 letter from the Dutch Minister of Finance to the Parliament, which (as well as highlighting the benefits) draws attention to some of the disadvantages of accrual based accounting experienced in adopting countries. These are:


- Excessive complexity
- Reduced accessibility of financial data for members of the legislature
- Little value added
- Decentralisation of authority away from the political level and towards the administrative level

The same letter goes on to summarise the results of academic research (which it admits is meagre) on experience of accrual accounting. Here are a few selected quotes:

'...an accrual based accounting system makes it more difficult to compare financial performance from year to year...'

'...limited importance that management assigns to accrual basis information...'

'...the extent to which Members of Parliament understand and use accrual basis data is unclear...'

'...there is little doubt among academics that accrual basis accounting does not live up to up to the ambitious expectations of its advocates...'

'...the application of these [private sector] standards to the public sector is driven by a naive conviction of the superiority of the financial tools used by the private sector. In the English speaking countries this conviction is expressed in the willingness to adopt accrual basis accounting without a robust understanding of its effects.'

The Minister suggests that '...caution is warranted in the implementation of accrual accounting by central governments...'

The doubts expressed in the Dutch letter are not isolated. I also attach a piece from the US Government Accounting Standards Board expressing similar doubts and an article by Alan Robb and Susan Newberry raising concerns about the constitutional and political implications of adopting business-style accounting practices in the public sector based on New Zealand's experience. And there is, of course, Andy Wynne's article on the subject suggesting that accrual accounting is a 'fad' that has had its day.

I'm a bit of a fence sitter when it comes to the adoption of private sector accounting approaches in the public sector (I am an economist after all!), but I think it would be interesting to have a response to the issues raised from those better qualified to comment. My major concern is at the level of transparency and accountability to politicians and the public: can the theoretical benefits of private sector accounting approaches applied in the public sector be outweighed in practice by the increased complexity and reduced accessibility of the financial information provided, so that only the cognoscenti can interpret it? Ian Ball maintains that accrual accounting is essential for transparency, but Andy Wynne suggests that this is an assertion that is not supported by the evidence: who is right?

[Yves]

Thanks to all of you for all theese comments and critics concerning my private sector approach of public statements. Of course, and I say it clearly in the introduction of my prospective study, adaptation of private methods should be handled carefully as the citizen expectations are much more wider than the optimistic and  sometime devastating financial target of 15% return on equity of private firms shareholder (as a banker, believe me that I have to fight permanently with greedy behaviour of human nature); Nevertheless, and in a complementatry analysis of traditional methods, the set of indicators in conclusion of the essai could be used in a srict idea of analysing (or managing) the financial balance of public sector financial situation, as for the figures, it could be a kind of tranparent, understandable and standardised way of presentation of public financial statements.
This is the lack of datas and sources of information I feel during assignments when the question is to determine "soutenabilité" (bearability?) of budget   

[petagny]

Yves,

I like the sound of 'a complementary analysis of traditional methods'. This seems consistent with my first post. The different approaches tell us different things and have different degrees of accessibility to layman, politician and technocrat, respectively: we therefore need to retain (or develop) different perspectives on the public finances depending on the purpose and the user (whilst getting rid of practices that are clearly flawed - like your example of booking borrowed money as revenue) and to consider the costs as well as the benefits of accounting reforms (particularly in less advanced countries). Would you agree?

[STONE]

Do the UK's Whole of Government Accounts fit the bill in terms of this accounting analysis of the public sector?

http://cdn.hm-treasury.gov.uk/whole_government_accounts200910.pdf

[STONE]

At 200 pages and with a lot of qualification by the Comptroller and Auditor General it seems the Dutch Minister might have a point.

[petagny]

Listen here to Niall Ferguson making a case for improved public sector accounting (and fiscal austerity!) in his first BBC Reith Lecture:

http://www.bbc.co.uk/programmes/b01jmx0p

You don't need to agree with all of his prescriptions (which might make more sense once some degree of macroeconomic stability is regained) to find this thought provoking stuff.

Let's not forget that the off-accounts liabilities he talks about were there well before the subprime and eurozone crises and did not cause these events: the first is a typical bubble, made much worse by globalised financial markets and under-consumption by China; and the second is the result of an ill-constructed monetary union without the support of the necessary institutional and political arrangements. Better accounting would not have prevented either. And public sector deleveraging at the same time as massive private sector deleveraging can only take us to a very scary place indeed.

On the other hand, I am convinced that in the longer term Ferguson is right that liberal democracies need to restore and protect their institutions. For those that are interested, Francis Fukuyama's recent book, 'The Origins of Political Order', looks at the origins of these institutions and the forces that cause them to decay, including those based in evolutionary biology.

[Napodano]

As received from Yves

----------------
Chers amis,
 
Encouragé et dirigé par mon ami et confrère de l'inspection générale des finances, Alain-Gérard Cohen, j'ai travaillé sur une nouvelle approche des finances publiques.
 
Ancien banquier et analyste financier, actuellement expert en finances publiques auprès de l'Union Européenne, je me suis posé durant mes diverses missions à l'étranger les questions suivantes: qu'est-ce qu'un Etat, vu à travers le regard d'un financier? Jusqu'où peu-on faire le rapprochement avec une entreprise privée?
 
Pour une meilleure transparence vis-à-vis des citoyens que nous sommes et une meilleure compréhesion de la situation financière des emprunteurs publics pour les investisseurs en bonds du trésor que nous sommes aussi, serait-il opportun et utile d'adapter aux comptes publics l'analyse financière comme on le fait pour les comptes des entreprises Renault ou IBM?
 
Les nouveaux outils de la statistique nationale conjugué avec une meilleure communication des acteur publics quant à leur situation financière (reporting) nous aurorise à le faire aujourd'hui.
 
C'est cette approche originale et pédagogique que nous avons menée à travers cet essai.
 
Nos conclusions sont très intéressantes!
 
Vous trouverez à travers le lien ci-dessous un premier article paru dans la revue "Banque" concernant cette vision nouvelle des comptes publics.
 
http://www.revue-banque.fr/management-fonctions-supports/article/pour-une-meilleure-lisibilite-des-comptes-publics

Un article plus complet avec plusieurs tableaux et schémas paraîtra dans 15 jous dans le supplément "Banque stratégie".
 
Enfin, une version en anglais sera bientôt disponible sur le site de la revue Banque
 
Bien cordialement,
Yves DANBAKLI
Fideï Finance Consultants
61, Rue Brauhauban
65000 Tarbes-France
Tel 00 33 5 62 93 35 13
e-mail: ys.danbakli@gmail.com
------------------------------

[Napodano]

Dear all,

As an ex-Crédit Suisse private banker and private financial analyst, I have recently (2006) entered PFM expert world. This gave me the opportunity to have a private look to public finance.

...........................

The article we wrote propose an essay of private analysis of public finance and a set of new indicators we consider more relevant for a fair and true evaluation of public finnace financial situation.

You will find then this article here joined written in French.

From that article Yves has developed a full paper tha can be found attached below (in French)

[Napodano]

Dear all,

As an ex-Crédit Suisse private banker and private financial analyst, I have recently (2006) entered PFM expert world. This gave me the opportunity to have a private look to public finance.

...........................

The article we wrote propose an essay of private analysis of public finance and a set of new indicators we consider more relevant for a fair and true evaluation of public finnace financial situation.

You will find then this article here joined written in French.

From that article Yves has developed a full paper tha can be found attached below (in French)

This is the English version