NBA accounting
There have been several articles in the press recently to the effect that the NBA is engaged in phony accounting to report losses when in fact they are making a profit.
The essence of these articles is as follows:
1. Although their financial statements are audited and certified as conforming to U.S. generally accepted accounting principles, the auditors and owners are lying, the teams are really making money.
2. The depreciation of players’s contracts, signing bonuses (which totaled $250 million at New Jersey Basketball at the end of 2004) is an accounting fiction used to deceive the players and IRS. What are accountants to do with a $250 investment, leave it on the balance sheet in perpetuity?
3. Rent paid to team owners ($2.2 million based on capitalized leases with a value of $23 at New Jersey Basketball) who also own the stadiums where they play are optional and another gimmick to make it appear that teams are losing money when in fact they are earning a profit. What the owners of the stadiums to do with their investment, write it off as a charitable donation?
4. Reporting player salaries of $52 million (at New Jersey Basketball) in addition to the amortization of signing bonuses is double dipping and more phony accounting. There are 2 items to be accounted for: player contracts and player salaries. How is accounting for each construed to be accounting for 1 thing twice?
5. It is interesting that none of these articles point out the $20 million (at New Jersey Basketball) of net cash outflow from operating activities in 2004 booked at the same time that the NBA borrowed $20 million from someone who must be repaid in real money. If someone puts that much money into an investment in the form of money that has to be repaid to a bank, isn’t this a legitimate investment that some day must be regarded as a cost? If this is not cost, exactly what is it?
To anyone who understands the principles of accounting, it is quite clear that the audited financial statements are not accounting fiction presented to delude players. These principles are followed in industries worldwide. Accounting standards were developed by some of the best experts in a public process where anyone could offer input. They are taught in all college accounting departments and used by all corporations that publish financial statements that conform to generally accepted accounting standards. What the NBA owners are doing in their financial statements in their reliance on these standards is not some hocus pocus deception.
What the journalists fail to point out is that most of the time owning a professional basketball team is a rich man’s entertainment, something to feed the egos of people with money to burn. In most teams, professional basketball is a massive transfer of wealth from the owners to the players. The players want more, as much as they can get. If they can get from people with a failing business model to continue this, good for them, but let’s tell it like is and not pander to one’s fantasies about the ignorance of readers. These journalists apparently believe that their readers are delusional and quite willing, on the advice of the writers, to dismiss all that has been learned in accounting over several centuries, not unlike the creationists who would have us dismiss the entire body of knowledge in biology, geology, astronomy and several other sciences.
As for me, if owners of these teams want to give away their fortunes to players, that’s fine, but it is not for journalists to represent reporting this for what it is as accounting trickery. They should instead report it as what it is, a transfer of wealth.
Recent accounting articles
I teach a class in International Accounting at UCLA Extension. To help students become better informed about current developments in accounting, I provide a collection of articles from various publications. The oldest ones are listed first.
1 Lease accounting
Today the IASB and the FASB announced agreement on a new standard for lease accounting. The big change, as expected is that there will no longer be a distinction between capital and operating leases. What we have called “operating leases” will become capital leases and be accounted for as such. http://www.nytimes.com/2010/06/23/realestate/commercial/23fasb.html
2 Revenue recognition
The IASB and the FASB have agreed on a standard for revenue recognition. According to the article: “ The core principle of the proposed standard ‘is that a company should recognize revenue when it transfers goods or services to a customer in the amount of consideration the company expects to receive from the customer…’” http://www.journalofaccountancy.com/Web/20103049.htm
3 Revised convergence date
The IASB and FASB announced that they will not meet the June 2011 deadline which the Group of 20 asked them to set as a target for convergence of accounting standards. They said there was not enough time for complete convergence, so their focus will be agreement on the major standards related to the financial crisis. http://www.ft.com/cms/s/0/5bb026aa-7fdb-11df-91b4-00144feabdc0.html
4 Future of Euro
Article by George Soros on the possible consequences if Germany withdraws from the Euro: http://www.ft.com/cms/s/0/88ded464-7ee6-11df-8398-00144feabdc0.html
5 Convergence plan
Plans for GAAP/IFRS convergence and education issues http://www.northbaybusinessjournal.com/22603/u-s-global-accounting-standards-reaffirmed/
6 Supreme Court SOX ruling
The US Supreme Court threw out a clause in the Sarbanes-Oxley Act. Since there is no severability clause in SOX, legal scholars had speculated that such a ruling would mean that the entire act was thrown out. This is not the case.
http://www.supremecourt.gov/opinions/09pdf/08-861.pdf
http://www.nytimes.com/2010/06/29/business/29accounting.html?src=me
7 Future of Euro
Arguments of 4 prominent German professors who had originally opposed the Euro, predict its demise. http://www.spiegel.de/international/germany/0,1518,703613,00.html
8 OECD Principles of Corporate Governance
2004 update of original 1999 publication. Referenced on pp. 181 and 306 of text, chapters 5 and 8
http://browse.oecdbookshop.org/oecd/pdfs/browseit/2604021E.PDF
9 Sarbanes-Oxley Act
ere is the full text of the law. http://www.gpo.gov/fdsys/pkg/PLAW-107publ204/pdf/PLAW-107publ204.pdf
10 Accounting Standards Codification
Article on the significance of this completed project.
http://www.financialexecutives.org/eweb/upload/fei/ferf_acad_ArunMisra.pdf
11 SOX 404: benefits>costs?
This study attempts to measure whether the benefits of Sarbanes-Oxley section 404, which concerns the system of internal controls, exceeded costs.
12 Euro decline forecast
An economic forecaster with a good record is forecasting a decline in the Euro to near parity with the US$ over the next year. http://www.bloomberg.com/news/2010-07-05/euro-worst-to-come-for-most-accurate-analysts-as-td-securities-sees-parity.html
13 IASB/FASB convergence schedule push back
Push back against the IASB/FASB schedule to complete in June 2011 issuance of pronouncements covering major areas of difference. http://www.webcpa.com/news/PwC-Wants-Accounting-Boards-Slow-Down-54904-1.html
14 Study habits
Alarming decline among American college students. http://www.boston.com/bostonglobe/ideas/articles/2010/07/04/what_happened_to_studying/?page=full
15 Derivatives
Explanation of how derivatives are used by farmers to protect crop investments, comments on financial reform legislation about to be signed. http://online.wsj.com/article/SB10001424052748704258604575361182317501188.html
16 Foreign currency: rupee
Symbol for the rupee recently created. http://www.nytimes.com/2010/07/18/weekinreview/18grist.html?_r=1&ref=weekinreview
17 Securities disclosure regulation
SEC had been aware of the kind of short term trades that Lehman Brothers and others used possibly to mislead. http://online.wsj.com/article/SB10001424052748704723604575379633816181998.html?mod=googlenews_wsj
18 Roche disclosure
There were extensive excerpts from Roche regulatory disclosures in the chapter on disclosure we discussed last night. Here is big news about a disclosure Roche made yesterday about a new drug. http://www.reuters.com/article/idUSLDE66K19120100721
19 International accounting systems
Sinopec, one of the world’s largest international companies, is based in China. They signed a contract worth $2.9 billion to centralize its accounting management system and a much smaller one for treasury. It affects thousands of accounting centers. ” The system aims to: standardize accounting standards and procedures, consolidate financial management processes, strengthen financial management and control, improve the access and analysis of quality financial information, and modernize the financial management group.” http://www.marketwatch.com/story/pansoft-signs-contract-with-sinopec-for-centralized-accounting-and-treasury-management-systems-2010-07-21?reflink=MW_news_stmp
20 Dell accounting fraud
Dell misreported payments from Intel for several years to make it appear that they were reducing costs. Quote from the New York Times: Reading the details indicates this case is more outrageous than many, a fact that more than justifies the $100 million corporate fine. Dell was taking secret payments from Intel not to use semiconductors from A.M.D., Intel’s rival, but the payments seem to have been based not on Dell purchases but on what Dell needed to make its quarterly numbers. The cynicism involved was immense.http://blogs.wsj.com/law/2010/07/23/a-bad-way-to-run-a-railroad-dell-pays-big-to-settle-fraud-charges/
21 Foreign currency risk management
When the history of the 21st century is written, the behavior of the government of Iceland will rank as one of the most catastrophic. http://www.bloomberg.com/news/2010-07-30/iceland-says-it-s-far-from-defaulting-on-payments-as-rating-nears-junk.html
22 Innovative financial reporting
Something to consider when reporting a loss. http://www.nytimes.com/aponline/2010/08/12/us/AP-US-ODD-Smelly-Bills.html?_r=1&hp
23 China slowly diversifies its forex holdings
Holdings in U.S. debt and US$ estimated at $1.8 trillion, slowly shifting to greater emphasis on South Korean and Japanese government bonds, allowing trading of Malaysian ringgit against yuan, more currencies to be added soon.
http://online.wsj.com/article/SB10001424052748703791804575439093644614592.html?mod=googlenews_wsj
24 Lease accounting proposal
Leasing industry in concerned that sale and leaseback deals will evaporate as a result of new leasing pronouncement.
25 China’s spectacular ascendance begins to reshape the world economy
Impacts include the basis of currency exchange rates, international trade, U.S. interest rates and role of the $ in international trade
http://www.guardian.co.uk/world/2010/aug/22/china-economic-growth-japan
26 Incompetent accounting
Bad accounting is extremely expensive. http://www.haaretz.com/print-edition/business/we-inherited-this-mess-from-kobi-alexander-1.309431
27 Yuan and dollar
Editorial on US policy toward dollar/yuan exchange rate http://www.nytimes.com/2010/08/24/opinion/24massey.html?hp
28 Lease accounting rule impact
More press on what this means. http://www.startribune.com/business/101195154.html?elr=KArks:DCiU1OiP:DiiUiD3aPc:_Yyc:aUU
29 FASB interim chair interview
Leslie Seidman, the interim chair during the search to replace Herz, is interviewed on current issues http://www.webcpa.com/news/Leslie-Seidman-55393-1.html
30 Cookie jar accounting
How one US company built reserves in good times to be used for income smoothing in a downturn – this is legal and accepted practice in Germany http://www.statesman.com/business/technology/sec-sues-two-more-in-dell-accounting-probe-884119.html
31 Derivatives
Analysis of the development and operations of this market
http://www.theamericanscholar.org/too-bad-not-to-fail/
32 Convergence overload?
Sir David Tweedie says complaints about overload because the timetable being too fast are not reasonable http://www.accountancyage.com/accountancyage/news/2266450/adoption-ifrs-remains-highly
33 US adoption of IFRS highly uncertain
The new chairman of the IASB Board of Trustees says US adoption of IFRS and funding of the IASB are highly uncertain http://www.accountancyage.com/accountancyage/news/2266450/adoption-ifrs-remains-highly
34 Europe’s IASB concerns voiced at global meeting
European Commission objects to governance and funding of IASB based on primarily on issues related to fair market value of bank assets
http://www.accountancyage.com/accountancyage/news/2260750/iasb-concerns-voiced-global
35 Audit reform
Note Jones comment on what is the point of an audit if it fails to uncover systemic risks that cause a global financial meltdown http://www.accountancyage.com/accountancyage/features/2266825/audit-change
36 Lehman EY investigation
US investigation of role of E&Y in Lehman collapse is hindered by international regulatory disputes http://www.accountancyage.com/accountancyage/news/2263343/lehman-investigation-blocked-eu
37 France and Germany asked to stop meddling with IASB
Herz says meddling from France and Germany are the key obstacle to convergence and declines comment on whether he will succeed Tweedie http://www.accountancyage.com/accountancyage/news/2251273/europe-stop-meddling-fasb-chief-4857963
38 PCAOB seeks public enforcement
Partly to reduce incentives for firms to drag out settlement of enforcement actions the PCAOB seeks to make their actions public like the SEC does http://online.wsj.com/article/SB10001424052748704206804575467582668103578.html
39 Bernanke on Lehman failure
In Congressional testimony expresses regret that he did not explain in September 2008 that the Fed could not save Lehman and lacked legal authority to do so because Lehman had insufficient collateral Partly to reduce incentives for firms to drag out settlement of enforcement actions the PCAOB seeks to make their actions public like the SEC does http://online.wsj.com/article/SB10001424052748704206804575467582668103578.html
40 Review of The Great Reflation
Book review of impact of Fed’s action to increase money supply – possible impact on inflation and economic growth http://seekingalpha.com/article/223467-book-review-the-great-reflation-by-anthony-boeckh?source=hp_wc
41 New IASB Trustees Chairman
Has considerable political clout in Europe and is strong defender of IFRS http://www.accountancyage.com/accountancyage/analysis/2266861/international-rescue
42 SEC failure at Lehman
Investigator says firms like Lehman were not regulated in a meaningful way http://www.sltrib.com/sltrib/money/49437092-79/lehman-sec-accounting-financial.html.csp
43 IASB Chairman replacement process and politics
Tweedie interview on EU pressure on IASB trustees re his successor http://uk.reuters.com/article/idUKTRE68839A20100909
44 Objections to IFRS private firm application in UK
Lot of work required to implement changes http://www.financialdirector.co.uk/accountancyage/news/2269830/letter-reveals-internal
45 Consequences of out of control off balance sheet accounting
Article on Lehman failure says FASB rules are so full of holes that banks can drive a big heap of CDOs straight through them http://www.newsweek.com/2010/09/15/lehman-s-clear-lesson.html
46 SME Standards set for adoption across the globe
Main obstacle in Europe is from France and Germany where accounting standards for non public companies closely aligned with tax legislation http://www.accountancyage.com/accountancyage/news/2256477/sme-standards-set-adoption
47 SEC: Still a Ways to Go on IFRS
Analysis of major issues in US adoption of IFRS from SEC perspective. http://www.complianceweek.com/article/6240/sec-still-a-ways-to-go-on-ifrs
48 SME reporting and IFRS
20006 interview where the IASB member most involved in development of IFRS for SMEs explains objectives and how IFRS will differ for large and public companies http://www.iasplus.com/resource/0602maltapacter.pdf
49 Adoption of IFRS will boost SMEs access to capital
IASB member leading IFRS for SMEs comments on how adoption of IFRS by nonpublic companies can aid international expansion and raising capital http://www.bernama.com/bernama/v5/newsbusiness.php?id=541821
50 Shorter Agenda for Convergence
FASB and IASB have selected 5 priority projects for focus in the next 12 months and deferred others as they continue efforts to converge http://www.cfo.com/article.cfm/14539711/c_14539812
51 IFRS adoption by country
Countries not adopting IFRS include Cuba, Guyana, Suriname, French Guiana, Iraq, Iran, Syria, Yemen, Uzbekistan, Turkmenistan, most of the northern half of Africa (except Morocco, Egypt and Senegal), New Guinea and some other Pacific Islands, Belarus, Nepal and Bhutan
http://www.pwc.com/us/en/issues/ifrs-reporting/country-adoption
52 Economists foretell of U.S. decline, China’s ascension
MIT economist Simon Johnson says ” The age of American predominance is over. The (Chinese) Yuan will be the world’s reserve currency within two decades. http://www.reuters.com/article/idUSTRE7082BL20110109?loomia_ow=t0:s0:a49:g43:r1:c0.200603:b40882506:z0
53 FASB, IASB: Convergence Priorities on Target for June 2011
Joint progress report says financial instruments, revenue recognition, leases, fair value measurement and off balance sheet risks will receive priority and other projects will be deferred http://www.journalofaccountancy.com/Web/20103607.htm
54 A Secretive Banking Elite Rules Trading in Derivatives
On the 3rd Wednesday of every month the 9 members of an elite Wall Street society gather in Midtown Manhattan to protect the interest of big banks in the vast market for derivatives The details of their meetings and identities have been strictly confidential http://www.nytimes.com/2010/12/12/business/12advantage.html?_r=1&src=busln&pagewanted=all
55 Tommaso Padoa-Shioppa, economis and politician, dies
Tommaso Padoa-Schioppa, one of the intellectual architects of the single European currency, has died aged 70 – what the article fails to mention is that he had recently been appointed chairman of the Board of Trustees that oversees the activities of the IASB http://www.bbc.co.uk/news/business-12031387
56 FASB backs away from mark to market
The FASB backed away from a mark to market rule that had gained preliminary approval in May 2010 and changed to allowing banking to amortize which is in line with the IASB
http://online.wsj.com/article/SB10001424052748704013604576104012708309774.html
57 Banks Have Their Way With FASB
Reflecting pressure from banks and Congress FASB backed away from an investor supported rule that would have required banks to reflect market value rather than cost for loans including real estate http://online.wsj.com/article/SB10001424052748704698004576104382179065752.html
58 Accounting Boards Aim to Align Balance Sheet Netting
The fact that some companies can, in certain instances, report IFRS balance sheet figures that are double the size of their U.S. GAAP numbers is not acceptable in global capital markets so the FASB and IASB are working to eliminate these differences with respect to financial instruments
http://www.accountingtoday.com/news/Accounting-Boards-Aim-Align-Balance-Sheet-Netting-57079-1.html
59 Why Enron Whistleblower Sherron Watkins Doesn’t Trust the SEC
She says that today she would take her information to WikiLeaks because the SEC has such an abysmal track record following up on major disclosures from whistleblowers – meanwhile Republicans and lobbyists are working to gut the Dodd-Frank act
60 Panel Calls for New Board for Private Company Rules
A panel founded by the Financial Accounting Foundation has recommended establishment of a new board supervised by the FASB to develop a separate version of GAAP for private companies
http://www.complianceweek.com/panel-calls-for-new-board-for-private-company-rules/article/195134/
61 Tweedie Takes a Bow
Interview about his work in the past 10 years as Chairman of the IASB, note comment about the role of technical partners in large accounting firms in resolving issues about principles
http://www.cfo.com/article.cfm/14551016/c_14551704
62 Accounting change prompts rethink of US leverage ratios
As expected the convergence of US GAAP with IFRS on derivatives with the prohibition of most netting will lead to financial reports that indicate a higher level of leverage since $6.8 trillion in derivatives will be added to balance sheets. About 97% of this will be at Bank of America, Citigroup, Goldman Sachs, JP Morgan and Morgan Stanley. Regulators will have to rethink rules on the level of leverage that is permitted.
http://www.risk.net/risk-magazine/news/2020059/accounting-change-prompts-rethink-leverage-ratios
Video: Dewey Norton career highlights and consulting expertise
This video provides an overview of some highlights of my career in financial management and discusses some area of considerable expertise that I offer to clients in the U.S. and internationally in most aspects of financial management primarily for technology and manufacturing companies. Here is the linke to the video which is on Youtube:
China trip notes
Just returned from a couple of weeks of vacation in Beijing. Learned a lot about the economy and business travel and confirmed more ideas. Here are my complete notes included cultural events and sites. Would be very interested to hear your comments and questions.
Visited the Forbidden City, the Great Wall, the Great Hall of the People, Tiananmen Square, the bird’s nest and the water bubble (I have only once previously had an interest in a tour of a stadium).
Preparations were underway for the 60th anniversary celebration of the revolution, which will be as meticulously prepared as the Olympics, so we look forward to watching this Thursday, October 1.
Seems like a nation of entrepreneurs with lots of proprietor managed stores the size of a closet, bicycle repair shops set up on the sidewalk. Was warming up to the idea of buying some food on a block filled with street vendors selling meat and vegetables on a stick, until I saw one filled with scorpions, some of whom were still wiggling. I think they cook these before you eat them, but I was not absolutely sure so I headed for a restaurant. Kentucky Fried Chicken has a 75% market share of the fast food market. At first glance everything seemed new: the tall buildings (as dense as Manhattan and as large as LA), highways, cars, trees, sidewalks. Pollution on the best day is worse than the worst day I have seen anywhere else, but much progress is being made.
Warning: if you think pedestrians have the right of way, you might not survive your first intersection. Crossing the street you have to be wary of what is happening in all directions and you have to be quick. Motorists turning where pedestrians have the light maintain speed and blow their horns. They will slow down if absolutely necessary to avoid killing you, but I would not want to test that idea.
Also went to a concert at the remarkable new National Center for the Performing Arts (the shell), riding a lot in the best subway I have seen, walking all over the place (no more difficult than Europe to navigate and get directions, always felt safe, people quite friendly), hutongs, palaces, great cooking at a lot of restaurants (instead of ordering a meal, you order several dishes which everyone shares) and visiting a bookstore about 3x the size of the largest in LA.
For those who think competition with China is about low cost labor, consider this: the density of people in this and other bookstores is 6x what it is here. Since I don’t know enough Mandarin yet to buy more books in this language, I decided to count the shelves on certain topics:
10 intellectual property, 10 cost accounting, accounting section was too crowded for me to be able to estimate the size, but it was huge, 10 customer service, 20 network security, 30 logistics, 50 French, 100 Java and C++, 240 economics, 500 contemporary Chinese literature in prose, 1,045 learning English. Aisles very crowded with people intently reading, exits filled with people carrying large stacks of books purchased.
Flying was what you would expect. Extensive stretching exercises helped going through 19 time zones. Non stop to Dulles coming back, 6,900 miles later followed by a short 2,200 mile flight to LA.
At a high level of government, I was asked a lot of questions about how China is regarded and how democracy works in America. Although people go to jail for remarks on certain topics, there is surprisingly great ferment and freedom to consider national alternatives on everything else – see my comments on the book What Does China Think? on GoodReads.com. A lot of serious thinking about the future.
In the last 30 years the country has moved from nearly the entire population at a subsistence level to 350 million reaching middle class living standards. People dress about the same as any place in the U.S., except the women are more conservative than LA. The one child policy: what would you do if the population had increased from 400 million to 1.3 billion from 1949 to the present? Generation gap there is bigger than in the US in the 1960′s.
Really Know Why Profit Margins Changed
Most executives do not understand why profit margins change
Your CFO has just presented the financial report. Sales decreased 2% over the prior month and 17% over the prior year, but gross profits decreased 6% and 41% respectively. He mentioned the role of fixed costs, discounting and the lower margin on a new product, but did not quantify these factors in his analysis. Everyone is used to this so while the sales and manufacturing vice presidents have somewhat different opinions on the relative importance of each factor, no one has any idea how settle these differences.
Insight into this change is critical to success
At the board meeting, one of your venture capital backers mentions that a competitor’s sales are flat but profits are increasing due to new products and focus on the most profitable market niches. One of the board members takes you to task on this. Why don’t you have a precise understanding of what is happening in your business and a program to at least match competitors’ performance? These are ominous developments for your company and your career.
Here is a proven, low cost method to analyze this There are financial analysis techniques that have been around perhaps for centuries to address this question, but they are very rarely used. I came across them at the beginning of my career as a financial analyst in one of the big automobile manufacturers and have since refined them to use with modern ERP systems and Excel.
What you need is the following data on each product for the two periods being compared: unit sales, price and cost.
The next steps, using Excel, are to calculate the change in gross margin, then analyze this separately for pricing, cost, volume and product mix.
Key findings from this analysis
Some findings from analysis I have done using these techniques that pointed the way toward increases in profits and cash flow are:
- A price increase, net of discounts and the cost of communicating discounts to customers resulted in no net increase in margins. The first time I presented this the sales executives walked out the meeting. After reviewing my analysis in detail, the group vice president then recalled them for a subsequent meeting in which they were instructed to understand my analysis and prepare a proposal on how they would address the issues exposed by my analysis.
- We had lower gross margins than in the prior year on some of our most important customers. An analysis of this by product indicated that customers were cherry picking our product line and sourcing some of our most profitable products from competitors. Armed with precise information on who was doing this and on which products, sales management was able to work with field sales people to address the problem and regain the prior, higher level of profitability.
- There were many changes in engineering design and manufacturing that collectively resulted in higher costs on some products. Knowing the precise impact of this by the part number provided management with a to do list that the CEO decided to monitor closely to address the issue. By the same token, we were also able to identify more precisely where costs were being reduced and implement changes that produced that result across many other products.
- In one company, the product mix was shifting toward the least profitable products. Knowing where this was happening and the profit impact led to changes in engineering, manufacturing and sales priorities that substantially improved profits.
Your CFO may be experienced or trained in this. If not, contact me at dewey.norton@gmail.com. I also find it illuminating to analyze this data at the level of customer and other segmentation levels depending on the nature of your markets and business.
FASB Cave-in on Mark to Market Accounting
Warning: the following expresses strong opinions that may not be good for the blood pressure of those with a strong faith in either political party
The FASB’s cave-in to interest group politics, the most craven greed that has driven our nation to near bankruptcy, diminshes the nation and the profession of financial management. By acquiescing to the threat of legislation that would undermine the authority of the FASB, the chairman and 2 other members have done the work of nutcake congressmen for them – they have effectively turned over the role of developing accounting principles to the most greedy, partisan congressmen. No need for legislation when the profession exhibits such a servile demeanor. As a 37 year financial management professional, former Corporate Controller of a NYSE company, former CFO and active member of international technical committees in the profession, I greatly regret to see this happening.
Combining this new opaqueness in financial reporting with the Obama administration’s give away of trillions to banking shareholders, it opens the way for Wall Street to embark on the next wave of looting the nation’s treasury. By the way I voted for Obama, but am not quite sure I made the right decision as every day it looks more like Bush III and it turns out that Geither was the brains behind Paulson.
The FDIC served the nation well for decades by taking over insolvent banks. The Resolution Trust Corporation helped the nation navigate it’s way out of another great Wall Street heist, the S&L crisis. It is amazing to see all this good work brazenly cast aside and the nation’s precious credit given away in a national crisis to precisely the same people who created this crisis. As I read of Goldman Sachs giant profits, their presence in the meeting to decide the fate of AIG, a meeting where the insurance regulator was excluded and the failure of the government to ask Goldman Sachs to take even the slightest haircut in this deal, utterly unlike the deal they are proposing with the GM bondholders, what I see is sleaze on the scale of the worst of presidents Grant and Harding. Of course the way money changes hands in the current round of deals is entirely different from the days when cabinet members and captains of industry would spend a few days together in their private Pullman cars in the Adirondacks. In the case of Summers, it was slightly in advance of his adminstration appointment. In the case of Geithner, it might be just a case of sending a choirboy to negotiate with a bishop.
At the end of this, the United States will have a debt to equity ratio at about the same level as Italy. Not surprising as the level of incompetence and dysfunction are about the same in both countries and in both national political parties in the United States. For years powerful Congressional Democrats have acquiesed and assisted in the developing crisis, and now the Republicans are wallowing in pathetic accusations of socialism and utterly failing in their responsibility to propose constructive alternatives. What is most astonishing to see is not one of the people who saw this crisis coming and took courageous steps to prevent has been appointed to a signficant position in the administration. Not sure what Volcker’s views on all of this were as they were not reported in stuff I saw in the New York Times or Washington Post, but he at least has a completely honorable record of public service.
Turn inventory faster and reduce costs
Holding excess inventory is costly and disastrous:
- It is an investment with no return thus reducing the firm’s profits, investment turnover and therefore return on investment.
- Personal property taxes and insurance must be paid for this avoidable investment.
- Manufacturing and financial employees waste time keeping track of it.
- It takes up space that could be used for productive assets.
- Manufacturing employees use it to hide mistakes in managing throughput.
- Engineering employees use it to hide mistakes in product design and development.
- Sales employees use it to hide the fact that they have deceived management with rose tinted demand forecasts for new products and promotions.
- Financial employees use it to overstate profits and to indulge their laziness in the task of accurate financial reporting.
- For all these reasons, it is a daily reminder to employees of management’s incompetence and it reinforces the idea that they can get away with ineptitude and lack of diligence.
When I started the program discussed here, the situation was dire:
- Cash flow poor and margins were poor.
- As a result the firm was in trouble with its lender and investor.
- The company had drastically cut costs for a lot of fat but also some muscle and bone such as capital spending on efficiency and quality improvement projects, product development, advertising, trade shows and management development.
- Inventory turnover was about half what well managed companies in similar businesses were achieving.
- Management wanted a program to reduce inventory, but no one was offering any ideas.
What would your rather do: fire a bus load of people and spend a fortune on search consultants or solve the problem?
As the leader of the finance and information technology functions, I was greatly troubled. A couple of years earlier I had attended a conference where I heard about an intriguing approach to identification of excess inventory. My proposal when I returned went nowhere because management’s attention was focused elsewhere.
This was frustrating, but bad situations present opportunities, so I developed and aggressively advocated a proposal to management to reduce inventory by at least 50% within 6 months. The proposal included a modest outlay for a simple, low cost, add on to our ERP system and very reasonable incentive bonuses to be paid as reductions were achieved with no compromise in service levels.
In the new era, management now enthusiastically approved my proposal. All objectives were achieved on schedule. The CEO was all smiles as he handed out bonus checks. Our image with financiers was greatly enhanced. You can do this too. If you want my help at a reasonable price, please write. Here is how we did it.
Download inventory records of part numbers, descriptions, where used, cost per unit, quantity on hand, quantities and dates used during the past 12 months. Download into the same database the forecasted demand for each part number:
Sort the part numbers into these categories based on forecasted demand and actual usage:
- All parts on hand for which demand is forecasted for products to be produced. This will exclude part numbers that will be used exclusively for warranty and service .
- Some of these parts will not be expected to be used within the next 3 months because these involved in product development. Appoint someone from engineering to manage this inventory. This person must report to management monthly on the status of this investment and obtain management’s advance approval for significant additions to this.
- For all remaining parts where demand is forecasted within 3 months, determine the optimal quantity for each part number. Compare the balance on hand to this optimal quantity. Do not permit purchases that will lead to quantities on hand in excess of the optimum. Do not permit purchases of any part number where these is a quantity on hand in excess of optimal levels until the excess has been consumed. Set up a reserve for 5% of these.
- The above takes care of sales from current production. What about service parts? The analysis for parts that have been sold in the last 6 months is the same as the demand for the production forecast in the next 3 months – analyze the balance on hand relative to forecasted demand, work to maintain inventory at the optimum level. Set up an obsolete inventory reserve for 15% of these.
- For parts where there have been sales in the last 12 months, set up an obsolete inventory reserve for 50% of these.
- For part where there have been no sales in the last 12 months, set up an obsolete inventory reserve for 100% of these.
The next step is to devise an incentive bonus plan for the people who are responsible for this program. The incentives will depend on the potential savings and other considerations, but bear in mind that the payoff in improved cash flow may be considerable.
It may be of substantial value to consider the profitability of the products as well. My recommendation for the analysis of this is presented in the section on cost/price/volume/mix.
Rely on your credit manager to tighten credit then collect receivables and reduce prices
Lenient credit is one of the most expensive ways of doing business
Sales people perennially ask for more lenient credit terms for slow paying customers. Consider this: if a customer takes an extra 90 days to pay, if they pay, and your firm pays 6% interest on its working capital line of credit, this is the equivalent of giving a slow paying customer a 1.5% discount. What would a 1.5% increase in your firm’s gross margin do for your cash flow if your slow paying customers getting this favor amounted to 10% of sales? If your sales are $100 million, this is $1,500,000 coming out of your bank account. Of course your are not leveraged to this extent so the reduced cash flow will be substantially less than this, but the point is, extending extra credit has a cost. And it gets worse. The slow paying customer is much more likely to fail and be a complete write off. Suppose your gross margin is 30% and your operating profit margin is 10% and 5% of these slow paying customers fail in this economy, but they are only 20% of your customer base. So you have receivables of $1 million that will be noncollectable and must achieve $10 million in sales to make up the lost operating margin on these slow paying customers that fail. What effort is required to increase sales by $10 million? What are your chances in this economy?
Rely on your CFO and credit manager for a rational analysis of difficult credit decisions that will ultimately enable your to under price competitors
As a CFO I have maintained trust with CEO’s for a long time by maintaining reasonable credit standards, which often means saying no, especially when the customer is not credit worthy and the margin is low - it often these go together. If collections are maintained at a strong level, the company’s working capital requirements will be lower, interest expense will be lower, the firm’s financial risk profile will be reduced and ultimately the company will be in a better position to reduce prices if necessary to take business away from competitors.
Mark to market accounting: Some say change the rules and make accountants lie! How about start a new bank that actually lends money?
The mark to market accounting principle was carefully defined and is widely agreed.
In America, one of the principles of accounting is FAS 157, which requires companies to record on their balance sheets the market value of certain kinds of marketable assets they own. The Financial Accounting Standards Board in the United States and the International Accounting Standards Board for over 100 other countries have studied this at great length with considerable help from other professions. They agreed that this should be a fundamental accounting principle for enterprises to follow in financial reporting. The Internal Revenue Service decided that this is fair for tax returns. Shareholders want to know this to help them determine the value of their investments.
Bankers need to defeat it to continue to prosper as zombies
So what’s the problem? Why do so many banks and their partisans in the media denounce this accounting principle? Why did the prime ministers of Europeans countries put unbearable pressure on honest folks at the IASB to renege on their commitment to principle? The simple fact of the matter is the billionaires who run financial services companies made catastrophically bad investment decisions and they do not want to admit it. Telling the truth in many cases will prove that they are insolvent, or zombies as economists now call them. No one has proposed an alternative to market value that professionals generally regard as fair or accurate.
Values can be reasonably estimated for troubled assets
So what if a bank intends to hold an invesment for an indeterminate time and then sell it at what they allege will be a higher value yet to be determined? How do they know the value will be higher? In what year will it be higher? How do they know that a credit default swap will be fully backed by AIG in a few years? How do they know that company will exist then? How do they know that a $600,000 mortgage on a house that sold for $600,000 to a family earning $19,000 a year in Riverside, California will not default when a comparable house in the same neighborhood in the nation’s epicenter for mortgage defaults just sold for $350,000? If the value is not going to be reported as $350,000, what value will be reported? Who will determine this and how? Why should shareholders have no right to know how the price paid compares with current market value?
What about the argument that market value is not readily known? For example, suppose that the founding partner in a consulting firm has introduced some promising new products, but he or she is in poor health, sales and margins have declined some recently and this person decides to pull out. The junior partner has a buyout option at market value. Obviously the value is not easy to determine. Believe it or not, but there are professionally qualified people in the United States known as appraisers who, for a reasonable fee, can figure this out. They do this all the time and deals are done on the basis of their analyses.
This is not something that can be answered only by mystics or politicians or corporate yes men. Nor do we have to trust the insights, judgments, independence and integrity of the financial wizards who got us where we are today. This is not a question that should be answered based on political expediency with answers supplied by lobbyists on a beautiful golf course in Scotland with travel on a private jet paid for with a government guaranteed loan from the United States Treasury to be paid back by our children and grand children.
Let failed banks fail and encourage entrepreneurs to start new, well managed banks, but set new rules based on what works
What if some really big banks fail? Where will companies get credit? This gets to the most interesting part, the area where capitalism always finds a way. Let nature take its course. If tax payer funds are needed, use these funds efficiently to provide capital for new banks managed by more capable bankers who will lend money unencumbered by a long record of failure, but only under stringent rules that prevent us from getting into another mess like this later. If a bank is too big to fail, break it up into pieces that can be allowed to fail if they are catastrophically mismanaged. If the too big to fail bank is foreign owned, tell them get with the program or get out.
I have read with a mixture of amusement and horror about Senator Dodd, the floor manager of the bank bailout bill, who could not explain the difference between a percent and a basis point, and Vice President Biden who thought the government web site on the stimulus bill had a telephone number, or our Treasury Secretary Geithner who supervises the IRS (you or I would have gone to jail for evading taxes like he did for years) and who was the brains behind his predecessor’s failed bank bailout, and Republican members of Congress who wax on about fiscal responsibility as if they or President Bush had ever displayed any. So it is unrealistic to expect these folks and their favor seeking lobbyists to come up even one good idea. Fortunately there is a carefully regulated, national banking system that works. It’s not too far away, in Canada. There is also a bank bailout that works and does not bankrupt a nation. It’s in a prosperous democracy called Sweden.
Reduce costs by improving business processes
Analyze the process before making a far reaching decision, define the deliverables and the timing
Most business owners and executives use rather primitive techniques such as a 10% cut in staff or outsourcing without doing any more analysis to support the decision than getting more than one quote. They are usually disappointed with the results. Cost reductions never make it to the bottom line, morale declines, arbitrary decisions made in haste come unraveled and have to be reversed in an expense and embarrassing way, vendor and customer relationships suffer.
By the time management understands that a mistake has been made, there is a considerable amount of damage. As you decide which processes are most problematic and require analysis, define the deliverables and the timetable that will be the responsibility of the project manager. This will reduce the risk of an unsuccessful result.
There are some highly effective techniques to analyze a process
- My favorite is an analysis of each activity in the process to identify sources of inefficiency, high cost and poor quality. Define the process, such as credit and collections or procurement, receiving and accounts payable. The process may cut across several departments and may include vendor and customer activities – if you can reduce a supplier’s cost you can reduce the price you pay, if you can reduce a customer’s cost of consuming your product or service, you can increase profits from this or at least make life more difficult for competitors. Then analyze each activity in the process. More on this below.
- Another technique that can supplement this is an analysis of the internal controls associated with the process. Are they adequate? Can they be bypassed without management knowing? The accounting literature provides the tools to perform this analysis.
- Flow chart the process – a picture is worth a thousand words. A flow chart should display all the activities in a process and ways of handling exceptions. The mental discipline required to do this will reveal any misunderstandings of the process and many weaknesses. This can be used to cross train employees so that the process is protected whenever some is ill, on vacation or resigns. It can also assist in assessment of controls and costs.
- ISO 9000 and 9001 certification have long been used to document processes. This is valuable because it forces an organization to say what they are doing and to do what they say. But certification does not imply anything about optimization. A process can be completely compliant with ISO and remain overly expensive.
- Six sigma can be quite valuable in reducing the frequency of error and this invariably reduces cost and improves efficiency.
Here is a highly effective technique you can implement now
Depending on the staffing of a company most of these techniques may require a consultant. The first one may not. Here is how to implement it:
- Define the process, take care to include all aspects including related vendor and customer activities
- List in chronological sequence the activities performed in the process
- For each activity, identify: inputs, the supplier of the inputs, outputs, the customer of the outputs (external or internal), cost, lead time and quality of the activity
- Classify each activity according to whether it adds value from the point of view of the customer – adding a feature to a product or service adds value, moving material or corrective quality actions do not.
Once this analysis is complete, analyze all the activities that do not add value. Your objective for these should be to find ways to eliminate these activities without affecting quality or delivery times. Then look at value adding activities that incur significant cost or have long lead times or have quality issues. What can be done about each?
The definition of the process should always be as broad as possible so that all important issues will be considered. People in several departments and possibly at vendor and customer locations will have to work together to achieve maximum benefit. There are many benefits from this collaborative effort.
