Analysts read cash flow statements. Analysts listen to conference calls. Analysts use earnings statements to make paper airplanes while listening to conference calls. Earnings mania is officially dying.
Soon all clued-in companies will deliver the balance sheet, cash flow and income statement plus notes in one nicely wrapped package. Even investors who don’t read the small print will wonder about companies that omit cash flow statements. Maybe they have no cash, will be the logical conclusion, one that could have grave (sell) repercussions for IROs. No cash today means more than it did three years ago when no cash, no product and no revenue was no problem.
The push to say more about cash is symptomatic of an investment culture desperate for the real story behind the bottom line. By far the most common method of cooking the books has been premature revenue recognition. Companies that have played with revenue have suffered the greatest loss in value. Even though it’s fairly easy to catch premature revenue recognition – why are your receivables four times your revenues? – investors don’t usually figure it out until the SEC finally does. Once the SEC forces a revenue restatement, the stock price starts falling – declining an average of 80-90 percent.
Heeding a wake-up call, regulators have been very busy this year trying to enforce accounting transparency. The US Financial Accounting Standards Board is in the process of reviewing a number of issues including revenue recognition, stock option expensing, measuring intangibles, off-balance sheet debt and special-purpose entities. FASB is also working with the International Accounting Standards Board to flesh out global accounting standards that will likely follow the IASB’s principle-based approach.
For its part, the SEC is tackling Enron’s special purpose black box head-on by proposing requirements for companies to disclose off-balance sheet arrangements in their MD&A. The commission is also putting pro forma out to pasture with a proposal requiring companies that use pro forma to clearly reconcile the difference between the pro-forma and Gaap results.
Before these new accounting rules started addressing common methods companies use to legally cheat on their financial statements, many retail investors didn’t really care what was on the balance sheet. It was short-term gain and earnings, earnings, earnings. Notice that companies aren’t getting hammered as much for missing earnings these days. It’s because investors are looking at different signs like cash.
Progressive IR practitioners and CEOs should now be talking about cash flow – even if there is none – because transparency is about providing the real numbers. And today, the potential cost of presenting the real numbers definitely outweighs the cost of hiding them.
