There are many important imperatives and factors which are not quantified or measurable by the traditional accounting system.
Human capital is perhaps the single most critical success factor for companies. But its importance cannot be captured or measured by the financial numbers. One can anticipate the failure of companies by observing the high defections within their middle and senior management ranks. The exodus of these key managers is the precursor to a much more severe problem, which can impact the continuity of execution and administration of the company.
Another intangible factor of the financial health is the morale of the staff. Although good morale of the staff does not always equate to good productivity, poor morale certainly spells trouble for the company. A reduction in the staff morale will result in reduction of the flow of constructive ideas and effective operation of the company. In turn, poor morale can cause the exodus of good staff and eventually a decline in the profitability and market share of the company.
Low morale is another intangible factor that cannot be measured using financial terms. High morale does not necessarily yield high productivity. Low morale is the definite formula for low productivity. The problem with low morale is that the flow of ideas is reduced, there is exodus of good staff and operations efficiency are affected in the process.
Unfortunately, the traditional accounting statements also do not measure the brand equity. Brand equity is actually the amount of good will resident in the brand. It is the added value endowed upon the product or service as a result of past investments and marketing of the brand. It is also an asset that the company must ensure that its value does not depreciate. Unfortunately, the brand equity is not captured in the balance sheet because of its arbitrary nature.
Another significant root cause of corporate failures is the quality of the CEO. Most turnaround situations arise because of incompetent CEO. Weak board of directors and the financial controllers are also a possible cause. Yet, the current accounting system in place does not measure the quality of these key management staff and board members. Other causes of failures include poor quality staff and dysfunctional corporate culture that are ill equipped to handle changes in the marketplace. The damage caused by such factors is often only manifested just prior to the financial numbers displaying the red flags.
Financial statements can give some amount of indication and warning signs. But they should not be solely depended upon to gauge the health of the company. There are many corporate and accounting scandals to testify that financial statements are insufficient.
The profitability barometer of a vulnerable company usually takes the form of negative or declining profitability. It may have been slipping for several years, consistently below the industry's average and compares unfavourably with the competitors. However, the declining trend is sometimes confused with many other factors such as poor economic conditions, shocks in the marketplace etc. An experienced manager needs to be able to identify the problems long before the financial numbers turn red.