Why does “Permanency of Investment” matter and what is it?

Ronald A. Bero, Jr., CPA/ABV, CVA, CFFA, CFF

Why does it matter? “Permanency of Investment” matters if one is involved in dealership law. The phrase “permanency of investment” appears in the statutes of approximately two-thirds of the 50 U.S. states.¹ For example, in section 218 of the Wisconsin Statutes, in order for an auto manufacturer to add an additional dealership into the market, one of the factors to consider is: “The permanency of the investment necessarily made and the obligations incurred by existing enfranchised dealers in the performance of their franchise agreement.”

What is it? In researching Generally Accepted Accounting Principles (“GAAP”), as well as several finance and accounting texts, the only definition found for permanency of investment was as follows:

Permanency of Investment. If a man does not wish to withdraw a loan, it is an advantage to him to have it continue for a long period, because he is thus saved the loss of interest which would occur during the time of transfer, and the trouble and inconvenience of finding another borrower. This is of special benefit to widows, orphans, persons retired from business, and all those persons who wish not to labor with their own capital themselves, but only to live upon the interest of it.

This isn’t in any way relevant, nor is it current. In fact, it’s from 1882.² As is often the case, the language is subject to interpretation.³

First, “investment” is the outlay of money for income or profit and/ or the property purchased.⁴ For example, the assets of a business are investments of the owners of that business. The balance sheet of every business is made up of three general accounting components: assets (investments), liabilities (obligations incurred) and equity (net position at a given point in time). Business owners invest in assets and incur obligations in the form of liabilities in the expectation of generating profits or increasing the equity position of the owners. An investment is fluid and continuously changing. For example, as inventory is purchased (invested in) and then sold, the investment realized.

Second, “Permanency” is the state of being permanent, enduring without fundamental or marked change.⁵ Permanent or Permanency is not a financial or accounting term and does not appear in GAAP. However, GAAP defines assets and liabilities relative to their current (i.e., less permanent / more liquid) nature to non-current (i.e., more permanent / less liquid) nature. Cash and other current / less permanent assets are listed first on a company’s balance sheet while more permanent assets such as buildings and equipment are listed last.⁶ Therefore, an asset’s permanency is inversely related to its liquidity.

Simply looking at the non-current assets on a company’s balance sheet will not provide the answer to what the “permanency of investment” is. The balance sheet provides only a snap shot in time of the business’ assets or investments. As already noted, investments are fluid, investments made in a business are ongoing and returns made from those investments can be kept in (re-invested) or paid out of the business. For example, a building owned by the business will appear on its balance sheet as a more permanent asset. However, from a permanency of investment perspective, if returns have been made as a result of owning the building, while the building itself endures both physically and on the balance sheet, the building investment has fundamentally changed. Simply put, cash was converted into a building but, through profits, the building investment is returning or has returned profits into cash.

In order to understand the “permanency of investment” made, it is necessary to look at a company’s financial history, if possible, to a time when the initial investment was made (the business was started or purchased by the current owners) as well as other points in which re-investments were made by converting the liquidity of cash into less liquid assets. However, at the same time, it is also necessary to consider the business profits since these represent a fundamental change in the investment or the conversion of less liquid, more permanent assets back into the liquidity of cash.

“Permanency of Investment” necessarily requires then, from an accounting standpoint, that investments made vs. returns or profits on those investments over time be reviewed. Some examples illustrate this idea:

• Investors just recently purchased a franchise. They just converted the impermanency of cash into more permanent buildings, land, equipment and goodwill (the right to sell and service the brand). The permanency of investment in this case is high.
• A business has been operating for years making profits with little reinvestment into the more permanent assets of the business. In effect, using its more permanent investments to generate cash or converting the more permanent investments into the impermanency of cash. The permanency of investment in this case will be low assuming accumulated profits outweigh the initial investment.
• Investors just completed a major facility upgrade. They just converted the impermanency or liquidity of cash into the less liquid or more permanent building asset. The permanency of investment in this case is unclear, and depends on the operating performance of the company.

In summary, while the phrase “permanency of investment” is not readily defined by accounting authorities or accounting textbooks, it appears to be used in the majority of state statutes. Since “permanency of investment” is related to liquidity and investments change frequently, to understand the “permanency of investment,” it is necessary to look at the history of any investment including both additions to the investment and returns made from it.

Ronald Bero is a Director at The BERO Group. He has served as an expert on valuation and damages assessment, as well as accounting liability, in a variety of contexts. For more information on this article, please feel free to contact Ron at ron.bero@berogroup.com.

¹ Based on our research, it appears that the phrase “permanency of investment” or something very similar to it appears in approximately 34 out of 50 U.S. states. For an example of this language by state, see the attached table.

² The Elements of Political Economy by Francis Wayland, Sheldon & Company, 1882.

³ The interpretation presented here is that of an accountant and is not intended as a legal opinion.

⁴ See for example: http://www.merriam-webster.com/dictionary/investment?show=1&t=1313518705.

⁵ See, for example: http://www.merriam-webster.com/dictionary/permanent.

⁶ Liabilities are also recorded in a similar fashion.

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