Financial Metrics Shenanigans
by Howard Schilit
Newly minted doctors are required to take the Hippocratic oath and pledge their commitment to practice medicine ethically.
Perhaps corporate managers should be made to study the Hippocratic oath and apply it in earnest when they communicate with investors. In so doing, they would pledge to never knowingly harm investors and always refrain from showcasing metrics that misrepresent performance. That day seems way off in the horizon. Until it arrives, however, investors must be alert to the following three techniques that management can use to obfuscate:
In this article
- Misleading Revenue Surrogates
- Misleading Earnings Surrogates
- Misleading Cash Flow Surrogates
- Conclusion
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- Highlighting a misleading metric as a surrogate for revenue;
- Highlighting a misleading metric as a surrogate for earnings; and
- Highlighting a misleading metric as a surrogate for cash flow.
Misleading Revenue Surrogates
Many people consider revenue growth to be an important and straightforward measure of the overall growth of a business. Companies also frequently provide additional data points to supplement revenue, providing investors with more insight into product demand and pricing power. Investors should welcome this additional information and analyze these supplemental non-GAAP (generally accepted accounting principles) revenue metrics to better assess the sustainable business performance. However, sometimes these revenue surrogates provided by management can be misleading and can harm investors if appropriate safeguards have not been put in place.
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Discussion
I loved this article, it could also be titled "Another way to cook the books". As I see a big push in companies to become more "metric"/"performance" based, these same issues identified in this article will also crop up in internal management metrics
posted over 2 years ago by Ric from Missouri
A great article filled with examples why one should always "ask the second question." Unfortunately one learns the hard way that all is not as it seems.
posted over 2 years ago by Walter from Texas
It is very hard to monitor these various companies and try to "interpert" their various devious ways to mask problems. Articles like this really help to keep us alert to various shananigans and not be fooled so easily.
posted about 1 year ago by Edna from Virginia
Even GAAP data can be suspicious. I have noticed that the cash flow devoted to working capital changes in many annual reports does not match the data shown on balance sheets. This often shows up as changes of inventories and receivables. As these numbers affect the operating cash flow, I wonder which is correct: the cash flow statement or the balance sheet? The apparent discrepancy casts doubt on the entire report, GAAP and Sarbox not withstanding.
posted about 1 year ago by David from North Carolina
A wonderful article, very useful information with good examples, thank you
posted about 1 year ago by Jerry from Arizona
Clearly, it is useful to monitor deviations from accepted standards as a means of detecting impending problems. However, it appears unlikely that the average person, however knowledgable, would be able to detect such deviations unless willing to expend substantial time/effort.
One simple alternate approach: any change should be considered suspect!
One unfortunate implication: financial reporting has returned to wild-west ethics, inspite of all the alledged standards in place. I have to wonder why such deviations from standards are permitted at all. Either you have rules, or you don't!
posted 11 months ago by F from Ohio
This makes me wonder about the financials being reported by Salesforce.com and Concur Technologies. Very cryptic revenue recognition and adjustments.
posted 7 months ago by Kenny G from California
