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Burgess Manuscript
True Value Impact Accounting
Re-Thinking Accountancy to Suit the 21st Century
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#2 - A COMPLEX SYSTEM
MANAGING FOR PROGRESS AND PERFORMANCE
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The global socio-enviro-economic system is very complex. Many parts of the system associated with economic performance work with amazing efficiency, but the social impacts have resulted in massive inequality and there has been dangerous and unsustainable environmental degradation.
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MANAGING IN A COMPLEX SYSTEM
Not easy, but not impossible
One of the big issues of the day is that there have been several generations of managers who have been taught a lot about how to manage for the maximization of profit in the corporate busines or in the financial sector, but very little about managing for social beneift or for environmental sustainability.
Worse, there has been a myth that corporate managers have a legal (fiduciary) respnonsibility to manage for maximum profit, and to do anything else would subject them to legal sanctions.
Resources of the community ... No ... not so quick
One would think that natural resources would be an asset of the community, but sadly, the rule of law may have preempted what seems like common sense so that the legal reality is something very different.
The Socio-Enviro-Economic System is very, very complex. It is a lot more than an 'economic'
system, because the process of creating financial capital (that is financial wealth) also results in
impacts on all the other parts of the system.
The way the system works is that the many various activities or flows have impact on the starting
state to produce an ending state. The STATE or CAPITALS are the equivalent of a balance sheet
in conventional double entry accounting. The FLOWS are the equivalent of the profit and loss
account in the accounting system.
These same ideas are similar to the way many of the processes in science work and also like the
processes in engineering thermodynamics.
STATE of the CAPITALS is changed because of ACTIVITIES or PROCESSES that are being
used to produce PRODUCTS, that is goods and services.
The FLOW associated with CAPITAL being used and new CAPITAL being created results in
value being created or not … in value add or value destruction.
STATE … THE VALUE OF THE CAPITALS
ALL THE CAPITALS
There are many ways to describe the 'capitals' and no universal agreement on how they should be segmented and described. In the case of TrueValueMetrics and TVIA the concept that has been embraced is that ALL the capital should be included in the accounting and analysis. The goal is to involve ALL the capitals, no matter how they are described.
After considerable evolution the TVIA segmentation has three elements at the top level, and then a large number of sub-segments nested below as follows:
- SOCIAL CAPITAL
- Human Capital
- Relational Capital
- Locational Capital
- Cultural Capital
- Spiritual Capital
- NATURAL CAPITAL
- Natural Capital
- Sun
- Land
- Air
- Water
- Natural Resources
- Biodiversity
- Ecosystems
- ECONOMIC CAPITAL
- Financial Capital
- Physical Capital
- Intangible Capital
- Knowledge Capital
- Institutional Capital
- Cultural Capital
The exact way in which the capitals are segmented is not of great importance. What is
important is that ALL the capital is taken into consideration and accounted for, and not simply
the financial capital.
Factors of Production
When I was learning economics around 1960 at Cambridge, we talked about three factors of production:
- Land
- Labor; and
- Capital
I have noted in more modern economic discussion that the concept of 'entrepreurship ' has been added and in some cases also knowledge. The study of economics originated well before the industrial revolution when the economy was driven by agriculture and trade more than anything else. Accordingly having land for agriculture was important, and labor to get the work done. Financial capital was needed for trade and to support agriculture activities from planting to harvest.
Accounts
Systems of accounting have existed since ancient times. There is evidence there was accounting going back to the building of the pyramids in ancient Egypt. About 500 years, in 1494, Luca Pacioli published a major work: the 'Summa de arithmetica, geometria, proportioni et proportionalita' which included a substantial section on business and double-entry bookkeeping. he core concepts described then have changed very little since then: that is the idea of double entry and the classification of accounts into Balance Sheet Accounts and Profit and Loss Accounts.
MORE ABOUT THE CAPITALS
STATE IS THE TOTALITY OF ALL THE CAPITALS.
CAPITALS change when there is an activity (or process) that has an impact on the capital. Most, if not all processes have an impact on more than one capital. When financial capital increases,there are changes in many of the other capitals, someimes positive, sometimes negative.
In recent decades, financial capital has increased substantially while at the same time there has been a reduction in natural capital, and within social capital there have been both winners and losers.
SOCIAL CAPITAL
SOCIAL CAPITAL comprises Human Capital, Relationship Capital, Locational Capital and Spiritual Capital. From the p[erspective of humankind, Social Capital is the most important part of the socio-enviro-economic system. Logically, an increase in SOCIAL CAPITAL should be main aim of everything that gets done.
For most of the past two centuries since the industrial revoilution and the invention of modern economics there has been an assumption that better profit performance for people and organizations would result in improvement in the STATE of people … that is an improvement in SOCIAL CAPITAL … and while this assumption works in a shortage economy with poverty and low productivity, it does
not work in the same way for wealthier, higher productivity surplus economies.
For these economies explicit actions to improve SOCIAL CAPITAL has to be the main priority.
Human Capital
Human capital … the STATE of people, of the population … is the most important capital and also one of the most complex.
The way human capital is numbered or quantified should be independent of conventional money … human capital should not be 'monetized' but should have its own unit of measure or unit of
account.
Relationship Capital
Social / relationship capital is the STATE of society. It is associated with human capital but can
be bigger or smaller than the sum of human capital depending on the way the comes together or
not.
Locational Capital
Quality of life is heavily influenced by the PLACE. The state of Social Capital is enhanced when the influence of PLACE is positive, otherwise not. Quality of life is influenced in many ways by the state of place, the state of locational capital.
Spiritual Capital
Quality of life is also influenced by 'belief'. The spiritual dimension of quality of life is difficult to explain, but there is no question at all that people who have 'belief' get comfort from this, especially in stressful situations. There is a negative component to this, in that some people choose to use spiritual belief as a basis for hate.
NATURAL CAPITAL
(3) Natural Capital
Nature is the foundation for everything, and a really amazing construct. The more humankind
learns about nature, the more amazing it seems to be, whether it is the natural world of outer
space or the micro-miniature details of particles that make up everything in the world we live in
… and then the question of how all of this fits together to enable live of every imaginable
variety.
But nature is also finite and potentially very fragile. During the last 250 years the deployment of
created physical capital has done massive damage to natural capital and probably made it
impossible for the essential equilibrium of natural capital systems to be maintained, This is an
existential threat that is recognized by most scientists but rather little by the general public and
especially many in political leadership, business and banking leadership and investors. Some
understand the risk but mostly action is too little and too slow.
To understand and manage natural capital, there are several elements as follows:
- Sun
- Land
- Air
- Water
- Natural resources
- Biodiversity
- Ecosystems
ECONOMIC CAPITAL
There has been growth in economic capital throughout the history of humankind going back millions of years. It has been accelerating all of this time, but it is only in the last few hundred years that economic capital growth has accelerated so very fast.
Economic capital is everything that humankind has created to make the socio-enviro-economic system work more efficiently. Becasue this capital is created by humankind it may also be changed and improved by humankind. This is important. While human nature may be difficult to change, and natural systems may be impossible to change, economic capital can be repurposed if people and society decide that changes would be an improvement.
The three main segments of economic capital are the following, together with the main sub-segments:
- Financial Capital
- Money / Currency
- Securities
- Physical Capital
- Buildings
- Infrastructure
- Machinery and Equipment
- Vehicles
- Working Capital
- Intangible Capital
- Knowledge Capital
- Institutional Capital
- Cultural Capital
Financial Capital
In the prevailing socio-enviro-economic system, the most important and powerful element of
performance is the growth of financial capital. Maximizing this growth has been the focus of
prestigious business schools for many decades, with financial engineering better rewarded than
real engineering. The distortions that have resulted are immense and it will be difficult and costly
to remediate the damage done.
A big part of Financial Capital is intangible. One of the most common forms of intangible capital
is the 'Goodwill' that arises when a company is purchase based on the value of stock that is in
excess of the net asset value of the company balance sheet. More broadly the value of stock
based on stock market prices in total is far higher than the total of the net asset value of the
related company balance sheets. In the 1960s the difference was maybe around 10% to 20%.
Fifty years later the equivalent calculation has a difference more like 200% to 300%, and for
some sectors of the economy even more.
Physical Capital
Physical capital has a big role in determining the efficiency of the socio-enviro-economic system. The efficiency of every process is a function of the physical capital that is deployed
to make the process work.
Physical capital includes buildings of which there are many type, and it includes machinery and
equipment used to produce goods and it includes infrastructure used for transportation and for
the supply of utilities like water, sewer, electricity and communications.
Physical capital enables the processes that produce the products that are the foundation for the material wellbeing of PEOPLE and SOCIETY,
Intangible Capital
Knowledge Capital
The knowledge that people have built up over the years that enables all sorts of amazing technology to be deployed to help make progress. Not only is there more knowledge, but more people have education that enables them to make use of this knowledge. To the contrary, there is so much knowledge that people may choose to make use of one part of knowledge while ignoring another part of knowledge, and in the aggregate be dangerously misinformed.
Institutional Capital
The organizational structures, systems, laws and regulations that go into making an effective
enabling environment for progress. There is no question that 'organization' is required in order to
get things done … it has been true throughout history … but there are also protections that are
needed in order for the system to be fair. While people have the capacity to be good, human
nature is such that there is evil that must be protected against.
Cultural Capital
The are many manifestations of culture including music, dance, theater, and art. Also there are
things like history, traditions, architecture and historic sites … and food. All of these give
meaning to life, and ground a society to the place and the traditions.
ACTIVITIES / FLOW / PROCESSES
Processes
Processes are central to all manufacturing and the efficiency of processes determines the cost of the product and the performance of the company.
In the modern world, most products flow through many processes in the course of production, and often through processes in different companies and/or in different places. At each step of the
supply chain there is a process.
The efficiency of a process has many dimensions. In most companies the most important of these is the money cost dimension which has a direct bearing on the profitability of the product and the
organization.
A process also has a social dimension and the impact the process has on people and society. One of these issues relates to workplace safety. Workers should not be at risk of injury because of the way a process is designed and operated. In some countries there has been substantial improvement in workplace conditions, but not everywhere There is also the issue of fair wages for the work that is being done.
In addition there is an environmental dimension and the many ways in which the process may have impact on the environment. The use of raw materials like iron ore, bauxite, phosphates, etc impact natural capital, as does the use of fossil fuels like coal, crude oil, natural gas deplete the stock of resources. Large scale processes like open pit mining damage the land in many different ways and often result in polluted water as well. Large scale agricultural production often starts off with deforestation which has a knock on effect into wildlife and biodiversity. Gaseous emissions into the atmosphere have degraded the natural system to a dangerous extent and probably caused global warming and destabilization of the global climate system with consequences that might well be catastrophic. There is also the problem of solid waste that results from most processes.
Very few companies know much about the environmental impact of the inputs to their processes ... a problem that gets more and more difficult as the supply chain gets longer and more complex.
Exchange / Trade
Exchange and trade have been important in giving people a better life, going back thousands of
years. Free and fair trade always delivers added value, though not always in an equitable way
between the parties.
Money has been an important part of making exchange and trade more efficient, and modern
money continues to have an important role in how the socio-enviro-economic system works.
(See more about EXCHANGE and TRADE later in this paper … page ?? )
Products
Products are an important part of the socio-enviro-economic system. Products … that is goods
and services … determine quality of life and standard of living. When there is a shortage of
product, quality of life suffers. Shortage has two forms: in one case there is enough money to buy
things but the product is not available, and in the other, the product is available but there is not
the money to buy the product.
For most of history the amount of product has been constrained by the ability to produce. In
recent decades … essentially since the 1970s, productivity has been so high that the global
economy went from being a shortage economy to being one of global surplus production.
Over the past fifty years, many essential products have become lower in cost, better in
performance and more profitable all at the same time, There has been disruption for this to
happen, and this has been achieved not only from an increase in productivity but also by making
more use of lower paid workers and moving production to less regulated and more dangerous
workplaces.
Products are also responsible for environmental damage during their production (see processes
above). Much of the environmental damage may be deep in the supply chain and not easy to
identify in the final product … but it is there.
Advertising has done substantial damage to the environment and society while helping to make
products profitable for companies. Almost all advertising aims for people to buy more even in
cases where people have absolutely no need for the 'shiny new bauble'! For advertisers and the
companies that pay them, more product sales is always better for the company … the best for the
customer is not part of this equation.
Streams
Products flow through the socio-enviro-economic system. It is a stream or a strand or a string
with IMPACT happening all along the stream from the beginning of the life of the product to its
end. A product comes together through multiple supply chains and then into the final production
process, and then a use phase, and finally a post use waste phase.
Initiatives to change the linear characteristics of product manufacture, use and disposal to flow
that has more circularity are growing in number and in scale.
It is very clear that the simple 'cost, price, profit' framing of decision making is not enough for
companies. Nor is simple price and presentation enough for decision making in the case of
consumers. Much more information about the 'stream' is needed.
This can be done implementing a universal system of 'standard value profiles'.
Sectors
For a long time … maybe a hundred years or more … analysis of the economy has been
segmented by SECTOR, and organizations like the World Bank, the UN and Universities have
been organized along sector lines. Technology has evolved within the 'silo' of the sector. To some
extent this has enabled appropriate specialization, but it has also been a constraint where multisector interaction is essential, as in a PLACE where people live and work. (See more about
SECTORS later in this paper … page ?? )
Place
There was a time in history when PLACE was very very important. The real estate mantra that
there are three important facts: 'Location, location, and location' was so very true of PLACE.
Major cities grew up in places that were efficient for the economy of the time and were mostly
on the coast and near the mouth of important rivers.
PLACE remains very important because PLACE is where PEOPLE live and where everything
comes together to enable quality of life or not. (See more about PLACE later in this paper …
page ?? )
ACTORS
People ... the Ultimate Actor
The Individual as Consumer
Some things cannot be directly influence by people. Human nature seems to change very slowly
if at all, and nature is both powerful and complex and pretty much established in how it works.
Otherwise, almost everything that happens is caused by the decisions people make. All the small
decisions made by almost 8 billion people aggregates to something of great importance. Some
individuals have more power than others, and different levels of leverage, but in the end it is
people that are going to determine how well people live and how all the critical issues are
addressed.
In conventional economic analysis there is much attention paid to the role of COMPANIES and
their PROFIT PERFORMANCE because this has impact on STOCK PRICES … but it also true
that it is PEOPLE that are associated with all of these decisions. (See more about ACTORS later
in this paper … page ?? )
The Individual as Employee
The Individual as Employer / Mid-level Manager
The Individual as C-Level Manager / Director
The Individual as Investor / Investment Manager
The Government as Actor
Activists from Civil Society
The Military as Actor
ACTORS
Implementing Entities
Every human being on the planet is in some way an ACTOR that has an IMPACT on what is
going to happen to themselves and to everyone else. Most individual human beings are also
organized in some way with others, whether it is as part of a family, a community, a company as
employee, a company as investor, a company as decision maker, a government as citizen, and so
on. In the end, it is people that make all the decisions!
ACTORS - PRIVATE SECTOR
Companies
For profit companies are the dominant form of organization for economic activity. The small
decisions or millions and millions of people become visible in the performance of the company.
This is important, because when companies make good decisions, there is good impact, and
when they don't there is bad impact.
People
Investors
Employees / Workers
Consumers / Users
Not for Profits / NGOs
ACTORS - PUBLIC SECTOR
Governments (Executive Agencies / Departments)
Executive agencies of government have both a lot of power and very limited power. The mix
depends very much on the country and the laws in place … not to mention how the laws are
applied. Typically they are not managed very well and the use of management information is
generally primitive!
Governments (Legislation / Regulation)
The legislative branch of government has a big role in the process of rule making and policy for
society, but they usually do relatively little to ensure that the laws and regulations actually do
what was intended … again, the role of management information is very limited if it exists at all.
Governments (Judiciary)
The Judiciary has a role in getting all the actors to follow the law and apply the rules. In some
cases this is done very well, and in other jurisdictions the judiciary is very weak and totally
ineffective … often simply by the simple expedient of limiting the budgetary funding for the
judiciary.
State Owned Enterprises (SOEs)
In purely technical terms the State Owned Enterprise should be able to perform as well as a
private Investor Owned Enterprise, but rarely does. Some of this is because there are some
critical government regulations that limit how an SOE may operate, and in some cases the staff
are recruited for political reasons rather than for technical and management competence. Where
the SOE uses government style management systems, the performance is always seriously
diminished.
Public-Private Partnerships (PPP)
The hope of Public Private Partnerships is that private ownership, management and money will
facilitate projects that are needed for the public at large and for which there is no political
appetite to fund and operate as a state initiative … toll roads and bridges for example. To a large
extent this form of organization enables profit for the private parties and high costs for the needy
public. This would be clear if such initiatives were accounted for in a clear and transparent
manner, but that is rarely the case.
QUANGOs (Quasi Non-Governmental Organizations)
Quangos (a UK idea) have some of the characteristics of the PPP . They avoid some of the
limitations of public sector operations, but do not have meaningful private sector incentives and
are really neither on thing or another.
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