Financial Intelligence - You can’t always trust the Numbers

Watching the business news regularly showed us that people creatively created their own way of cooking their financial books. From Massive Sales recording, Hiding Expenses to using Off-Balance Sheet Techniques and if you are whether into the business world or not you have been affected by the 2008 crisis and being involved in business or financial transactions you will be aware of how Huge Financial Institutions melt down in a matter of hours.

A funny example is the one huge tech company that wanted to boost its sales figures by shipping empty boxes (right before the end of the quarter) to its customers. Definitely, they were shipped back but recording was not in the same quarter.

Another famous example is Enron and how it became popular because of them using the SPVc (Special Purpose Vehicle) to go Off the Balance Sheet, hiding their massive debts and crooked assets.

The problem is that Accounting is just a science of numbers and as many results could be reached via different routes from just one input. Then a route is found towards Financial Reporting.

It is an Art of Showing Numbers and we never can assume a company is faulty due to adopting a specific Accounting Approach. At the same time, we need to understand that different presentation of figures can help a company in a month or two and / or a quarter or two, but it couldn’t change a company’s Financial Position from bankruptcy to profitable status.

It is very interesting how numbers can alter matters for instance, the technique of “One Time Charge” which takes advantage of a company’s good season to “charge” once and all for instance; bad debts, inventory write offs, removing numbers stuck on the Balance Sheet and etc.

So many reasons and consequently techniques used to twisting numbers. Another one was addressed in the front page of The Wall Street Journal about accruals where one company played around Retiree accruals without physical (Monetary) impact on these accounts which directly changed the bottom lines.

In Fact, adopting different approaches in Financial Reporting is not something that is considered either misleading or illegal and even big names in business has various Reporting approaches but these unusual or off the trend actions are always declared in the “footnotes” of a Financial Statement.

It was previously GAAP (Generally Accepted Accounting Principles) in the US and also majority of the world that used GAAP as a reporting and recording guide for accounting transactions which was governed by the FASB (Financial Accounting Standards Board) and now it is IFRS (International Financial Reporting Standards) governed by the IASB (International Accounting Standards Board) which include a wider content that fits a Globalised World Economy in which it sets accounting rules together in reliable way of fair display that yields a comparable Financial Statements giving Investors, BODs, Shareholders, Executives, Managers and almost all stakeholders various benefits either judgemental, operational and / or for Audit purposes.

Although, IFRS provides a detailed frame guide (NOT GOVERNING RULES) for relations of numbers and standards of recording and keeping books compliant in a widely accepted and comparable manner but as the world witness having those fraudulent and scammers we will unfortunately keep observing twisted Financial Reports.

Check Warren Buffet’s communication with his shareholders;

Then there are managers who actively use GAAP to deceive and 
defraud.  They know that many investors and creditors accept GAAP 
results as gospel.  So these charlatans interpret the rules 
“imaginatively” and record business transactions in ways that 
technically comply with GAAP but actually display an economic 
illusion to the world.

     As long as investors - including supposedly sophisticated 
institutions - place fancy valuations on reported “earnings” that 
march steadily upward, you can be sure that some managers and 
promoters will exploit GAAP to produce such numbers, no matter 
what the truth may be.  Over the years, Charlie and I have 
observed many accounting-based frauds of staggering size.  Few of 
the perpetrators have been punished; many have not even been 
censured.  It has been far safer to steal large sums with a pen 
than small sums with a gun.

Consequently, the focus point must be among the “grey areas”. As numbers in Financial Statements are estimates and could be artistically altered to serve the aim of a company (excluding any fraudulent action) ten we have to examine some crucial points like but not limited to:

A) Monetary VS Historical Values

EX: An Asset may vary in company valuation due to the difference between it’s Book Value and Current Value / Market Value.

B) Disclosure

EX: When a company decide to adopt one Accounting approach then turns to an opposite approach, actually no one will contradict and they are not questionable as long as it is IFRS compliant but also from a transparency point of view, it has to be declared and highlighted giving reasons.

(Such kind of action is very important to Investors and has a direct impact on their investment decision)

C) Consistency

Consistency & Disclosure are complementing categories. As consistency in accounting methods shows how a company is confident in its Presentation of Financial Figures, Disclosure plays the role of fixing any inconsistent action.

D) Conservatism & Materialism

This point requires books to be firstly, up to date in terms of recording sales, losses, write offs and any significant transaction that has an impact on Financial Statements.

Financial Statement users’ can examine these important points via an Operational and Financial Due Diligence process which investigate compliance of operations and financials processes.