By Damian Griffiths, Jan 16 2015 04:19PM
(or why the accounting rules for small companies are wrong)
Before the howls of protest ring out, I want to make it clear that I haven’t gone completely mad and I’m certainly not the first to have spotted that the rules that we’ve all grown up with are increasingly out of touch with 21st century business and in particular the hotchpotch of latte-inspired, bicycle-powered digital start-ups springing up in parts of London and other city centres.
Let’s start with ‘profit’ – a key measure of business success. It underpins the very real economic value of big business (think multiples and earnings ratios) and for that reason big business seeks to maximise profit in total, product by product and department by department.
Because the risks of over-valuation are feared more than under-valuation, the accountants have done their level best to make sure that as many costs are applied against profit as possible. So routine innovation designed to make products cheaper to produce or a little bit better, is treated as a normal cost of the business. It is written-off and forgotten. And for a long time, big business has cooperated fully with this treatment, eager at least to get a 100% tax credit in the year the innovation work is done.
Now look at how the same treatment is distorting the face of Tech City. By and large there are thousands of hugely talented creative geeks working away in small teams in London and elsewhere who are carving out just enough of a living to spend days and days inventing and trying out things that one day might be ground-breaking innovations. This whole sector of business, employment-rich is undoubtedly profit-poor (at the moment). By every current measure of productivity – the whole sector is a productivity nightmare.
But now turn it around. What if all that time currently being expensed against profit were excluded, deferred or capitalised? Of course the tax rules would need to change so that these young businesses weren’t suddenly clobbered with much higher tax bills – but in essence the whole sector would suddenly become much more profitable and valuable.
And so why does this matter? Well recently the Mayor of London was complaining about the paucity of small start-ups in London making the leap from start-up to large scale business. The suggestion is that they get eaten up rather quickly by the mega-corporations. The accounting treatment matters because at present, the rules ensure that profits (and therefore valuations) stay low and the true value of potentially ground-breaking innovation is written-off time and again.
Wouldn’t it be better if the huge success story of the Silicon Roundabout and its neighbours were given the chance to step up to the next level? And at the same time it would make the lousy productivity figures look a bit better too.