A True Accounting For Profits

Cash-rich companies need an excuse to do better on the environment: Impact weighted accounting can give them the cover they need.

On the surface, there’s perhaps little that seems exciting about a big consumer products company like Proctor & Gamble. Dish soap. Toothpaste. Laundry detergent. But beneath the surface, P&G is oozing cash at levels so remarkable, it’s a wonder the company doesn’t earn more accolades for being one of the best-run companies in America. A quick look at the company’s statement of cashflows bears this out. Its operations threw off nearly $17 billion in cash while making just a little over $3 billion in capital expenditures.

And P&G is not alone. Apple’s operations threw off $104 billion in cash and its statement of cashflows shows just $11 billion in capital expenditures. Over at Pfizer, operations threw off almost $33 billion in cash, while the company made just $2.7 billion in capital expenditures. In fact, there’s lots of companies like this among the S&P 500.

What do these companies do with all this cash? There is no single answer, but they all pay a lot in dividends, and buy back a lot of their own stock. Apple shelled out more than $100 billion in dividends and share buybacks last year. P&G spent $19 billion in buybacks and dividends. Pfizer paid $9 billion in dividends.

These are not untenable uses of cash. Dividends and buybacks enrich hedge funds and institutions, but also cops and teachers through their pension fund holdings. And no one is saying these companies are poorly managed. Quite the contrary. To throw off that much cash with such low levels of capital expenditures is a mark of excellence. Further, nobody is saying these companies are ducking their responsibilities when it comes to addressing environmental, social or governance standards, in the conventional meaning of that term.

Still, the amount of cash they are generating suggests they could be doing more. Maybe a lot more. For instance, P&G could figure how to rid the planet of all the hard plastic containers they populate the earth with. Pfizer could raise the wage standards for all of their low-level employees. And Apple could manufacture their products in the United States where there is a more robust environmental agenda.

Even if these companies wanted to do this, they couldn’t. Why? Because the pillar upon which capitalism rests, profit maximization, means that significant expenditures that are not mandated, such as the ones above, diminish profits, and capital and talent will flow to the companies that are maximizing profits.

This is not some theoretical construct. Profit maximization is supported by powerful enforcement mechanisms. Remember, in 2017 P&G got into a heated proxy fight with activist investor Nelson Peltz. Peltz, who called P&G a “suffering bureaucracy,” ultimately won a seat on the board. So, in this case, the validity of the management team was put into question simply because they weren’t working fast enough.

In an environment like this, how does a company divert resources for say a wholesale re engineering of its products to eliminate pollution, or enhance its wage structure when there is no mandate, and when it will eat into profits? Why choke the golden goose?

One way to do this is to bring so called impact weighted accounting into the picture. Impact weighted accounting is a simple concept with far reaching implications. Specifically, it recasts financial statements taking into account the costs borne by all of a company’s stakeholders. Net, net, it shows who pays and how much for a company to earn its shareholder’s profits. 

Here’s some examples: 

The Harvard Impact-Weighted Accounts Project shows a group of nine large global oil and gas companies with a positive margin for earnings before interest, taxes, depreciation, and amortization over multiple reporting periods swung to a negative 329% margin when taking into account environmental impacts. 

For a set of 13 packaged food companies, research by the Harvard Project showed operating earnings swung to negative 103% when taking into account externalized costs. Distributing foods with high sodium and sugar levels is profitable for these companies, but the attendant healthcare costs, plus environmental impacts, analyzed in impressive detail, are losses the public bears.

It’s important to note this is not a Big Brother proposition where the federal government tells companies like Proctor & Gamble what they can make. Quite the contrary. They can make whatever they want without government interference. However, what impact weighted accounting does is give them some cover to make hard decisions.

The proposition here is that if investors and corporate boards knew the breadth of expenses the public bears in the company’s pursuit of profit, they might make different decisions. The board of directors might re-imagine the business to lessen the impact on constituencies other than shareholders. Investors, with a full accounting of the cost of doing business, might decide to deploy their capital elsewhere.

The quality which gives impact-weighted accounting its promise is also its greatest weakness: honesty. Because if the senior management of companies are honest with themselves and shareholders, they know they are externalizing their costs, in some cases a lot of them. And if they know that, they know or at least recognize that the absence of a mandate to do better is not necessarily a good reason not to do better. But capitalism is a tough nut to crack, and it may yet prove impervious to what facts and analysis lay out in black and white.

But the information is out there, and companies are able to look inward to calculate these costs on their own. For the moment, we can only count on the better angels to do so.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.