Sunday, May 1, 2022

The Accountants Can't Make You Rich

In business cost per unit may be the ultimate metric. Accountants focus on in decreasing the numerator. Marketers focus on increasing the denominator. 

It is important to remember, though, that cost containment is not a growth strategy. Accountants almost never remember this. However, it is a necessary but not sufficient condition for long-term success. This is true of economies, firms, and individuals. In a future post I will explore this giving the importance of the metric its due.

You can't grow your wealth by harvesting investment losses--you can't just "write it off" after all. Reducing unnecessary costs is an important part of sustaining a firm, but it is not a complete recipe of a succeeding firm. This is why so many mergers and acquisitions fail to add value. Cost reductions through economies of scale are generally very difficult to realize, and even when they are realized, they are often temporary. Ultimately, successful mergers come down to realizing synergies for new growth without cost exploding. Compounding the problem of pulling off a successful merger (one that justifies the purchase price of the target being acquired) is that the hoped-for synergies prove in many cases to be imaginary and as often unforeseen at the outset--more luck than skill.

Looked at from a broader view, a society with high savings and poor investment will be an impoverished people who are soon forgotten. To be clear the alternative isn't simply live for today, but at least those of the Bacchanalia had a good time while it lasted. The miser who squirrels away his every penny under the mattress has nothing to show but a desire for yesterday's purchasing power.

The cost reduction impetus gets maximized in a recessionary environment. Firms and individuals tend to look inward in times of economic stress thinking more and more about how to voluntarily shrink to avoid forced shrinking. This can be both helpful and healthy. Yet taken to extreme, which can come quite easily, this becomes a self-fulfilling feedback loop. 

The cutbacks one should make are reductions in consumption. This is a lot easier at the individual and family level than at the firm level. Firms shouldn't have "consumption" per se. To the degree they do this is simply excess that should be trimmed away in any environment--easier said than done of course. Investment choices may and likely should change given changes to near-term outlooks. At the same time the risk of overcorrection is very great. 

An asset allocation should be largely immune to changes in the investment near term. The investors "going to cash", "moving to the sidelines", and selling out otherwise in times of stress in the financial markets are almost always making critical mistakes. Sometimes those mistakes are permanently devastating

Back to the general concept of keeping the accounting department happy, accountants usually aren't thinking in terms of calculus--only calculations. What I mean by that is they aren't looking at rates of change and the signs on the derivatives. Lest we degrade them unnecessary, the marketing department's version of calculations can amount to astrology mixed with magical wishes. At least the accountants are doing real math.

Those exaggerations aside keeping an eye on cost is essential. Focusing entirely on cost is deadly.



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