I’ve w.adjuvancy.com/wordpress/19693-2/” target=”_blank”>bitched and moaned about the way public corporations manipulate the reporting of their financial information. Where they remove items they don’t feel is germane (like a division that failed; or the drag on earnings is removed), or decided that EBITDA (earnings before interest, taxes, depreciation and amortization), Adjusted Net Earnings, and/or Adjusted Sales should be the valid measures for their performance. Because their true performance is abysmal. ( I won’t even mention which firm tried to promote the indicator EBE- earnings before expenses; in other words, just gross sales for the firm.)

But, there are reasons why- in addition to reporting GAAP (Generally Accepted Accounting Principles) results- certain information needs to be included in reporting. Like when a company is rapidly growing- which means that the yearlong results don’t reflect the rapid change in revenue that occurs month by month.

In such firms, the real situation is hidden when one is only reporting annual results. Or, a major new product or service is coming on line and the introduction costs are stupendously affecting results. For many of our trucking clients, a key issue that describes their performance is the capacity utilization for their trucks and trailers. Or, for manufacturing firms, how often they turn over their inventory (5 to 7 times a year is industry average; churning that inventory 12 to 24 times means a high utilization and efficiency of operations).

What the standard reporting numbers don’t tell you are when a firm that cuts advertising, which may mean current profits are up (less expenses), but future sales are being hurt. Or another firms that is cutting R&D- that improves the bottom line today, but can kill the company tomorrow. Or, as we know from our governments, failing to maintain infrastructure (like the DC Metro system, or on a national scale- our bridges and roads) may look really good for current expenditures (including the fact that there are no deficits)- until the bridge falls down or Metro can no longer service its rail system.

And, as I have also reported, financials are just a blip in time – especially for the smaller entities that use cash-based accounting. These situations become pretty evident when there is a foreign exchange conversion cost (which happen when you sell an item overseas at $ 2000, but by the time the foreign sale is converted back into dollars, you only receive $ 1900).  It is also critical for such firms to examine their performance using the accrual basis, so that potential changes (like a looming shortage in cash reserves) becomes evident.

There’s a new book “The End of Accounting and the Path Forward for Investors and Managers”, [Wiley] written by Drs. Baruch Lev (New York University Stern School of Business) and Feng Gu (State University of New York at Buffalo) that discusses these and other issues. The authors note that stock-option expenses, prospective bad debts, pension liabilities are truly prone to manipulation (not to mention they are also error-prone). Such data greatly change the accountable earnings for the firm.

The authors want more data like same store sales (since overall corporate sales may increase as a firm extends to more outlets where their goods are sold) and book-to-bill ratio be included as additional GAAP accounting data, as well as some of the indicators I’ve listed above. So, that the financial data actually can provide an idea of how well a firm has done- and how well it will be performing tomorrow.

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