Non Financial Evaluation
By their nature financial statements exclude missed sales, missed opportunities, the cost of mistakes and latent risks relating to past sales. They may include “goodwill” arising from an acquisition but this is merely a balancing item for accounting purposes, rather than a detailed breakdown of the intangible assets and intangible liabilities which were acquired. Financial statements exclude internally generated goodwill and use “blunt instruments” for assessment of things like depreciation. They ignore forward-looking information such as the order book, the innovation pipeline and the options and flexibility that management have to respond to opportunities and threats which occur from time to time within a dynamic marketplace.
To assess the quality of management you need to look not only at past achievements but at the quality and credibility of future plans relative to competitors. This means looking at the non financials, or the intangibles, such as
- Ways of working
- Leadership style
- Methods of communication, motivation, reward
- Determination of management to succeed
You need to look not just at the numbers but behind the numbers, to identify the critical success factors, the key performance indicators, the early warning signs, the risks and steps taken to reduce risks (mitigants) – this is why Financial Analysis has to be supplemented by Non-Financial Evaluation.
Soft Credit Rationing and Hard Credit Rationing
Soft credit rationing exists where as business is able to allocate its own financial resources to specific business activities, to specific projects or specific opportunities. The rationing is said to be soft because the decision to allocate resources rests within the control of the organisation. Where the organisation needs to seek external financing the rationing of credit is said to be hard. (Hard Credit Rationing).
A sign of good management is that they are good at this capital allocation process, they make good choices as to where to invest and they base their decisions on:
- Financial analysis, including the use of financial ratios
- Financial appraisal processes such as cash flow, payback and net present value calculations
- Risk analysis, including identification of different types of financial and non financial risks together with identification of options to remove, accept, avoid, mitigate or transfer them
- Appraisal of the business, its sources of competitive advantage and disadvantages relative to competitors
- The opportunities for value creation and options available to the business bearing in mind the competitive and ever changing marketplace
Businesses which are good at soft credit rationing have an automatic advantage over those who are not when it comes to seeking external sources of finance. The skills of soft credit rationing are totally transferrable when seeking “Access to Finance” from banks and equity investors (hard credit rationing).