business unit analysis should also be adjusted to eliminate the growth in sales rev-
enues and expenses due to inflation.
(b) Financial Projections. The need for financial projections to assist in strategy se-
lection gives the analyst an opportunity to depart from the historical cost accounting
convention. The effects of inflation must be incorporated into any financial projec-
tion. Financial projections are quite often presented in both nominal currency and
currency with a constant purchasing power.
In countries with high rates of inflation or in the case of foreign subsidiaries sub-
ject to strong variations in exchange rates, it cannot be assumed that one need only
change the nominal currency projections. The presence of rapid change in an economy
can have market effects that change the underlying assumptions used in the constant
dollar projections. For example, with an extremely high rate of inflation in consumer
prices, if wage levels are not keeping pace, there is often a shift in consumer prefer-
ence to goods possibly at the lower level of the price scale, away from mid-sized cars
to smaller cars. The same situation can occur when the exchange rate moves against
the local currency. This causes an inflationary rise in prices of imported goods, which
leads to shifts in consumer goods to domestic goods, where they can be substituted.
Implicit in the preceding analysis is the need for multinational strategic business
units to consider inflation rates in the foreign country or countries, inflation rates in
the home country, and exchange rates between the two in making strategic financial
projections. Each of these must be incorporated in the calculation of projections in
such a manner that it may be easily changed to reflect changing conditions.
(c) Portfolio Analysis. At the corporate level, where management is dealing with a
portfolio of strategic business units (SBUs), it is also essential to consider the effects
of inflation. Using the Boston Consulting Group’s growth share matrix, as shown in
Exhibit 20.3, we can see that strategy for a strategic business unit is partially deter-
mined by market growth.^5
Unless the analyst has adjusted market growth for inflation to arrive at “real”
growth, the company could embark on the wrong strategy. For example, if apparently
high market growth for a low market share SBU is adjusted for inflation to a low real
market growth, the company should be following a “divest” strategy instead of the
“build” strategy that a high market growth, unadjusted, would signal. With a high
market share, the company could be holding when it should be harvesting.
20 • 6 ACCOUNTING FOR THE EFFECTS OF INFLATIONStrategyMarket High
Growth LowLow High
Market SharesExhibit 20.3. Growth/Share Matrix.
Build HoldDivest Harvest(^5) Shank, 1989, p. 33.