Reorganized Balance

One Aspect I Appreciated About McKinsey’s Approach to Organizational Valuation Technology

One aspect I appreciated about McKinsey’s approach to organizational valuation technology is the method of reorganizing financial statements. Below, in the photo, the reorganized balance sheet is presented.

In the reorganization process, operational assets and liabilities are arranged first, followed by non-operational items, and finally, they are overlaid with sources of financing. However, this is not the usual terminology of the cash flow statement.

Operational items include those assets and liabilities that serve the company’s core business activities. The primary goal of separating these is to calculate Invested Capital accurately, so that ROIC can be derived without error.

For example, the operational cash item does not refer to the cash the organization has on the balance sheet, but to the cash it needs for operational activities (commonly taking approximately 2% of revenues). The remaining amount is listed under non-operational items as excess cash.

The essence of reorganizing the balance sheet lies in evaluating the organization as a collective of operations. Assets and liabilities that do not pertain to its core activities should be separated and assessed independently as they carry different risks.

This process is quite complex and requires in-depth strategic knowledge of the business. Which asset is core, and which is not? Which liability is operational, and which is financial?

For example, in the United States, it was recognized that rent/operating leases are substantively financial liabilities. Therefore, if I am not mistaken, from 2020 onwards, the capitalization of assets acquired through operating leases is required on the balance sheet (I am unsure how it is handled in our region).

Soruce:

#VALUATION – Measuring and Managing the Value of Companies7th Edition McKinsey & Company, Tim Koller, Marc Goedhart, David Wessels