Due diligence is not new to today’s managers who regularly witness, during acquisitions, the investigatory process which can be both exhaustive and exhausting. “In part it exists to avoid legal liability, lest the takeover fails, and leads to shareholder litigation. But mostly due diligence seeks to ensure that management knows precisely what it is acquiring, and avoid unpleasant surprises.” Explaining thus, Shlomo Maital and D. V. R. Seshadri take the concept of due diligence to a higher plane in ‘Global Risk/ Global Opportunity: Ten essential tools for tracking minds, markets & money’ (www.sagepublications.com).
Country due diligence
Urging managers who seek to do business in new geographies to follow a similar, thorough investigatory process, the authors discuss ‘country due diligence’ as an integrating tool, bringing together the other nine tools, which include risk management, tracking booms and busts, analysing engines of growth, and tracking trade and forex.
Advising that country due diligence can help you spot risks in markets where others see only opportunities, and vice versa, the authors mention the example of China, where one of the earliest American companies to invest was General Electric, even when others saw only risk.
“In global investment, as with management of technology, there is a classic dilemma of first-entrant advantage (the advantage of being first, in a market, or in a new technology), and second-entrant advantage (the advantage of being second, or third, and thus learning from the mistakes of the pioneers).”
Macro accounting
Resolution of dilemmas of this nature depends on solid fact-gathering. To facilitate the same, the book provides a ready checklist broken into sections, beginning with macro accounting. The first poser for which managers have to find answers is on the country’s GDP (gross domestic product) and GDP per capita, measured in dollars, at prevailing exchange rates, and also using purchasing-power-parity exchange rates that reflect the real, underlying value of the currency.
Next, see how the GDP cash flow looks like, ‘the sources of GDP and its uses, the proportions of GDP brought by households, governments, businesses and foreigners.’ Third, study if the country’s GDP is growing, and at what rate. Also, ‘how the annual increase in GDP – the growth dividend – used: for consumption, investment or exports.’
Insightful questions
Here is a sample of further questions in the macro accounting section:
•“Is the country present- or future-oriented as measured by how the GDP divides up between personal and government consumption, and investment and net exports?’
•“How much of each additional GDP dollar is spent by households on personal consumption, and how much is saved? How have these important proportions been changing?’
•“How large is the country’s net addition to its stock of buildings, machines and equipment, and how does it pay for that investment – out of its own saving, or through borrowing the savings of foreigners?’
• “How fast is the country’s capacity to produce goods and services (potential supply of GDP) growing, relative to demand growth? If demand is outpacing productive capacity, is there a threat of future inflation?”
Wish our trained professional accountants had ready answers to these questions, for the geography closer home, drawing inspiration from the recently-released Budget Manual!
Countries are businesses
Economies are made of small, medium, and large-sized businesses, and therefore countries are businesses, argue Maital and Seshadri. They suggest that by understanding some basic principles of the conventions of national accounting (the so-called GDP, and its components), and merging these with keen observations of clients, markets and daily business, managers can do no worse in their forecasts than economists, and often, far better.
The book educates students of finance in concepts such as ‘economic depreciation’ (or capital consumption) and indirect business taxes, the parts of GDP which never reach individual citizen’s pockets. The former is the value of a nation’s capital goods (fixed assets) that either wear out or become obsolete during a period of time, and thus require replacement; deducting this from GDP leads to NDP or net domestic product, wherefrom you derive NDI or net domestic income by subtracting indirect business taxes such as sales taxes.
Ant and grasshopper
You may remember the kindergarten story about a grasshopper hopping and chirping about, singing to its heart’s content, on a summer day, even as an ant walked by, laboriously carrying a piece of grain. “Why not come and sing with me instead of working so hard?” invites the grasshopper, but the ant talks about storing for the winter. “Why bother about winter? We have plenty of food right now,” says the grasshopper…
Narrating the fable in a box, the authors see the US as the quintessential grasshopper, using up 86.5 per cent of its GDP for personal and public consumption, whereas China is the perennial ant, with gross capital formation (the part of GDP invested in building new capital assets) larger than personal consumption. “In America, gross capital formation is barely enough to cover capital consumption.”
Germany, in the authors’ view, is somewhere between an ant and a grasshopper, consuming proportionately less than the US, though far more than China, and saving more than the US, though less than China. “China and America are, in a sense, bookends, bracketing extremes of present and future orientation. Like the grasshopper, America now finds that winter has come, and that it can no longer survive as it has in the past…”
Four markets
The global economy is an ecology, comprising highly interdependent national economies that interact through trade and capital flows, observe Maital and Seshadri. (Interestingly, they trace the two words economy and ecology to the same Greek root, oikos, meaning the house. “Economy deals with managing a household, or small or large group of people; ecology deals with the science of households – how people and other living organisms interact with their environment.”)
The authors identify four key macro markets, as the ecology of every economy, with each market defined by a quantity and price, by what and how much is being sold and bought. The first is the market for ‘services and goods,’ where demand and supply are balanced by market prices, tracked either through the consumer price index or the GDP deflator.
Labour, the second market, brings those who want to supply labour together with employers who need it, at agreed-upon wages. And capital market, the third, has as its products cash, notes, bills, bonds, stocks, certificates of deposit, mutual funds and so on.
The fourth market in the model is that of foreign exchange, the world’s largest single market, with ‘no rules except one – if you make a deal, even if you lose your shirt or your job on it, you must pay up.’
Recommended read for professionals aspiring for the big picture.
**
BookPeek.blogspot.com
Published - September 29, 2010 03:46 pm IST
