Strategy, the Accounting Equation and the failure of Arrium

If I remember rightly, the very first thing you learn in Accounting in first Year Uni is the Accounting Equation.  The fundamental framework that underlies the recording of a business’s activities.

Assets = Liabilities + Shareholder Funds

It means that for everything a company has, there is a claim on it by either the owners of the company, or by those that the company has a liability to (i.e. its suppliers of labour, inventory, cash etc).

But its actually more than this.  Bear with me, its actually the basis of strategy!

Everyone’s heard the lie line “the purpose of the company is to increase the wealth of the shareholders”.  So the Board of Directors can believe they are acting correctly and ethically when they pay out dividends, even if this slowly compromises the company’s ability to survive.   Almost certainly this will also shaft the suppliers to the company.  So when a Board ignores warnings and continues to give cash to shareholders, Administrators need to step in to start looking after suppliers.  i.e.  Looking back to our Accounting Equation, the shift in strategy becomes obvious – the emphasis moves from looking after shareholders, to looking after those with the Liability  (the Shareholders).

This isn’t abstract, it translates directly into the real world.  Have a look at Arrium.  Since One Steel became Arrium in 2012, it paid out a large percentage (41%+) of its profits as Dividends.   Despite plenty of warnings that trading conditions were deteriorating, despite profitability diminishing, and having to maintain crushing debt levels.  It still looked after the shareholders.  Only in 2015 did it have to call a halt to the Dividends.  There was no building a war chest to make the company more resilient.   Consequently, the Administrators have taken over and will now look after the Creditors, to the detriment of the Shareholders.

So the fundamental strategy of a company isn’t the value proposition of a company that it takes to a market segment,  it’s how it balances the competing needs of owners and suppliers so that it can survive!