Bolger, William J.

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eGrove (Univ. of Mississippi)

Management Services: A Magazine of Planning, Systems, and Controls Volume 4 Number 3 Article 8 5-1967 Costly Fixed Attitudes Toward Fixed Assets William J. Bolger Follow this and additional works at: https://egrove.olemiss.edu/mgmtservices  Part of the Accounting Commons Recommended Citation Bolger, William J. (1967) "Costly Fixed Attitudes Toward Fixed Assets," Management Services: A Magazine of Planning, Systems, and Controls: Vol. 4: No. 3, Article 8. Available at: https://egrove.olemiss.edu/mgmtservices/vol4/iss3/8 This Article is brought to you for free and open access by eGrove. It has been accepted for inclusion in Management Services: A Magazine of Planning, Systems, and Controls by an authorized editor of eGrove. For more information, please contact egrove@olemiss.edu. Many companies that keep close control over most cost and profit aspects of their assets neglect completely their investment in real estate and buildings. Yet con ­tinuing attention here may offer handsome possibilities  for substantial savings —COSTLY FIXED ATTITUDESTOWARD FIXED ASSETSby William J. BolgerHoward P. Hoffman Associates, Inc.The investment in and costs re ­lated to fixed assets deserve continuing close attention. Fixed assets, whether owned or leased, are a necessary ingredient of every business. If the management and control of this necessary ingredient  are treated positively and in a con ­structive and creative manner, these assets can become significant con­tributors to financial success. Con­versely, if fixed assets are regarded with a negative attitude or are un­intentionally ignored, hidden and unnecessary costs often result.Consider the following examples of the unsatisfactory results that apathy can produce:A well known company owned a plant built in stages from 1880 to 1965. The buildings had been put to hard use, and maintenance had  been deferred for a number of years  because of divisional operat ­ing losses. To stem continuing losses and avoid heavy carrying  costs, the plant was sold quickly  for one million dollars, more than three times its net book value.  The purchaser, a real estate in­vestor, spent $75,000 demolishing the buildings and six months later  sold the land for $4,800,000.An important company had an option to purchase a building in which it leased part of the total space. Under the terms of the op­tion, the option would be canceled if the company failed to approve a lease for space it did not lease in the building. The landlord tendered a lease for approval and in the waiver included the language: “The  optionee consents to this lease and cancels its purchase option.” The optionee was not compelled to agree but did so indifferently, later stating, “We did not want to be in  the real estate business.” Post­script: The optionee could have sold the option for $350,000, con­tinued as a tenant, and still avoided being in the real estate business.Contrast the excellent resultsMay-June, 1967 551Bolger: Costly Fixed Attitudes Toward Fixed AssetsPublished by eGrove, 1967A building tenant who casually agreed to cancellation of a purchase option it had on its building later found it could have sold the option for $350,000.achieved by companies that re­garded a problem as an oppor ­tunity:Offered a settlement to vacate its truck terminal and terminate its lease, a company determined the property’s true value through a market analysis. It was able to ob­tain four times the settlement or­iginally offered. This money was used to construct facilities twice as  large with a carrying charge that came to less than the old rental.Another company timed a pur­chase, rental, and sale to occur simultaneously and completed structural changes in eleven weeks. This action eliminated a long-term $300,000 annual obligation on a building that had been empty for three years, and the company re ­alized a $500,000 profit on the com­bined transaction.These are just a few examples of the experiences of corporations that were “not in the real estate busi-WILLIAM J. BOLGER is vice president of Howard P. Hoffman Associates, Inc., New York City. In the past he was depart­ment head, audit opera­tions, at Guaranty Trust Company of New York; assistant manager of loans, operations, andcustomer services at First National City Bank; and assistant treasurer at Crane Company. ness.” The use of quotation marks is deliberate; these words are fre­quently used to express the anti­pathy many corporate managers feel toward real estate.This antipathy is in some ways  surprising. Careful examination of the financial statements of most publicly or privately owned com­panies would show total net book investments in fixed assets, includ­ing land, buildings, and machinery,  of between 35 per cent and 50 per cent of net worth. (These percent ­ages are before capitalizing on the balance sheet certain leases tanta­mount to installment purchases, in accordance with the accounting procedure established in Opinion  No. 5 of the Accounting Principles Board.) Business has an important investment in real estate.Necessary evilSince most managers would pre ­fer not to be in the real estate busi­ness, it is logical that they would prefer to own or lease a minimum amount of real estate consistent with operational needs. There are bases for this feeling.Once the initial investment has been made, land and buildings are not usually regarded as measurable contributors to profits. Ownership of property involves the problems and costs related to an investment.  Such investment might involve us­ing cash, the sale of common or  preferred stock, the creation of debt, or a combination of these. Leasing, of course, incurs a direct  cost payable from each sales dol­lar. Keeping the property invest­ment to a minimum permits funds to be used profitably elsewhere, thus tending to increase earnings. Furthermore, the managements of organizations not in the real estate business naturally prefer to stress the business they know best and in which they are most qualified.When antipathy toward being in the real estate business is combined with consideration of the large in­vestments and costs required to house the business, the conclusion that real estate is a “necessary evil” is understandable. As a result, how­ever, the manager who regards property negatively as a necessary evil is unable to think construc­tively and positively about its profit­making potential.When real estate is viewed as a necessary evil, an appropriate pol ­icy is to keep the investment in and costs related to land and build­ings as low as possible. Here, how­ever, many companies fall down. They fail to establish and execute  a consistent program for keeping this investment and these costs at  56 Management Services2Management Services: A Magazine of Planning, Systems, and Controls, Vol. 4 [1967], No. 3, Art. 8https://egrove.olemiss.edu/mgmtservices/vol4/iss3/8the optimum level consistent with operating requirements and profit objectives.All too often, as a result of ex­pansion, acquisitions, broadening of marketing efforts, and other  needs at the time, sales offices, laboratories, plants, warehouses, and land for expansion are added year after year. It is easy to over ­look such increases in investments  and costs when per share ear ings  are increasing and the total net book value of land, buildings, and machinery is remaining relatively constant or even declining. If busi­ness conditions change, the result may be unwise liquidations. A firm policy for maximizing the invest­ment in and costs related to prop ­erty should be instituted when the economy and the company are prospering.Positive programA shift from negative attitudes to a positive program can lead to dramatic improvements in earnings and freeing up of capital. Such a program is outlined in the re ­mainder of this article.The investment and costs re ­lated to land and buildings should  be reviewed frequently. This re­view necessitates preparation of a full inventory of land and build­ings, either owned or leased, and a full breakdown of the investment and cost, including depreciation, rent, taxes, insurance, and main­tenance. Photographs (including aerials if possible), plot plans, sur­veys, and complete descriptions of improvements should be part of the resulting portfolio.This material should be reviewed periodically by key staff and line  personnel. Such a review will serve as a reminder of the need for ac­tion and change as operational and  financial needs change. Compari­sons of maintenance, tax, and other costs per square foot of similar facilities will suggest the need for appropriate programs. For example, high taxes may reveal discrimi­natory tax treatment or may reflect  changes that make the property more desirable for a higher eco­nomic use.In analyzing a company’s fixed asset position, the manager should keep in mind that real estate deci­sions are different from other busi­ness decisions because the “prod­uct” is different and the market is different. Each property should be analyzed as a separate business that is required to earn a satisfactory re­turn on the investment. The amount for which a plant can be leased to provide fair value for both owner and renter should be determined, without reference to the fact that the company either leases or owns a particular plant or warehouse. Even though the question of lease vs. ownership may have been con­sidered at the time of a property’s acquisition, the decision should be reviewed periodically. If a property is leased, at what price might there be an advantage in purchasing it? The answer in terms of current con­ditions will not necessarily be the same as those reached earlier.Many a company that has blithely added sales offices, laboratories, plants, and warehouse through years of rising sales has been forced to liquidate when business conditions changed radically.For example, in 1955 a well known company entered into a fif­teen-year lease for a distribution branch in a Western city. The  length of the lease was based on the company’s experience that growth had necessitated relocating  facilities after fourteen or fifteen years.At the tenth year, however, anal­ysis of the lease costs and the business of the Western branch suggested that the location would be advantageous for ten or more additional years. As a result of negotiations with the lessor, man­agement was able to choose be­tween purchase of the property at an attractive price or an immediate reduction of the rental upon execu­tion of a lease extension.Utilization analysisEach property should be ana­lyzed in terms of its use to the basic business, the ways in which its utilization may be improved,May-June, 1967 573Bolger: C stly Fixed Attitudes Toward Fixed AssetsPublished by eGrove, 1967There are many situations where property, while not causing an absolute loss, would be far more valuable put to another use for the company.and the effect on the business of discontinuing its use. These factors, again, apply whether the property is owned or leased.Often declining profitability at a given location provokes a deci ­sion to close down or relocate an operation. Yet profitability analyses should not be confined to opera­tions that are in trouble. There are  many profitable operations that would be even more profitable if they were relocated. With chang­ing conditions, formerly efficient layout and work flow patterns may become inefficient without actually making the operation unprofitable. Many such situations can be cor­rected by renovation or rearrange­ment. Sometimes the property would be more valuable foranother  use and could be sold for enough to replace the facility and improve operations while reducing the capi­tal investment.Each property should be ana­lyzed both in its present state for  its current use and in possible  modified states for use by another  company or for commercial or resi­dential use.For example, a well known re­tailer for many years had occupied  a building as its headquarters and principal store under a long-term lease. With ten years remaining  on the lease, it obtained from the landlord a settlement payment equal to five years’ rent to cancel its lease and move. This arrange ­ment permitted the retailer to move to a better location and a more modern building. The landlord also profited since he converted the building for office use and im­proved his return.Total costs of fixed assets should be added up, and regular fixed asset cost and investment budgets should be established for use in conjunction with other key budgets. This is a basic but often neglected procedure.The well known discipline of a specific budget is just as effective in controlling property costs as in  controlling the costs of sales, ad­vertising, production, and other op­erations. In a review the customary criteria used for all budgets will apply.ResponsibilityThe specific responsibility for supervising and controlling the con­tinuing investment in and costs re­lated to fixed assets should be as­signed to a key executive whose primary training and orientation  are financial. His status in the or ­ganization should be high enough to permit him judiciously to cross lines of authority in marketing,  finance, and production to assess  the priority of needs and to relate  such needs to financial objectives. If the size of the company permits  it, this executive should be sup­ported by personnel experienced in real estate finance, negotiations,  planning, engineering, construction, taxation, and marketing. The ob­jective is to relate the business’ fixed assetrequirements to the real  estate business in order to mini­mize immediate and longer-term in­vestments and costs.Take the case of a large freight forwarding company, which needed a new terminal and offices adjacent  to a large city. An analysis of oper ­ations had showed that profits would be increased by this expan­sion if total annual rental costs were $2.50 a square foot or less. Operating personnel made tenta­tive arrangements to lease a build­ing to be constructed for the com­pany’s use at an annual rent of slightly under $2.50 a square foot.Analysis by real estate personnel showed that the landlord would ob­tain an adequate return at about  half that rental. Factors analyzed included the value of the land, ar­chitectural fees, construction costs, plans and specifications, mortgage  financing, and the landlord’s pro ­jected return on equity and residual value. After correlating these fac­tors, with only slight modifications in the plans and specifications, the  real estate personnel succeeded in negotiating a lease for the same term at $1.10 a square foot an­nually.Negative attitudes toward fixed assets should be changed to posi­tive and constructive policies. The steps necessary to make this change are simple to establish. Handsome rewards can be attained with man­agement support on policy and the attention of qualified person­nel. Fixed assets and the costs related to them deserve much greater attention than they are getting.58 Management Services4Management Services: A Magazine of Planning, Systems, and Controls, Vol. 4 [1967], No. 3, Art. 8https://egrove.olemiss.edu/mgmtservices/vol4/iss3/8

Costly Fixed Attitudes Toward Fixed Assets

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Costly Fixed Attitudes Toward Fixed Assets

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