Veritas – Why the world needs accountants to ‘speak their mind

Few investors might expect the issue of financial statements to be a topic of fierce debate, but the standard practice of summing up a company’s performance using statistics on a handful of pages is arousing some strong emotions.

Those examining how well entire countries sum up their financial health have also got somewhat ‘hot under the collar’ this year.

The latest financial industry practitioner to throw fuel on the accounting fire is S&P Dow Jones Indices, which today described efforts by American companies to give a detailed break-down of where they sell their produce as “poor at best”.

About half of companies in the S&P 500 do not report “sufficient information to facilitate a complete report on global sales”.

Where sales’ origins are broken down, “disturbingly” often no further detail is given on ‘foreign sales’ – other than that they were from outside the US.

S&P Dow Jones Indices speaks of “nice pictures and messages from senior management abounding”, but cases of management actually saying where the earnings came from are “far and few between”.

This is, in part, because Generally Accepted Accounting Principles do not require such details to be in accounts.

Before the 2008-2012 crisis, this did not matter. A customer in Washington was as likely to pay a company as a customer in, say, Athens or Madrid.

All that has changed now.

As customers to American firms fell away in peripheral Europe, and possibly will also do in the US as it faces its ‘fiscal cliff’ next year, US fund managers have increasingly focused their sales pitches on the growing percentage of sales a US firm could make outside the US and Europe – notably in the emerging world.

By extrapolation, finding this out also mattered to fund investors.

But S&P Dow Jones Indices notes it is devilishly hard to do.

For example, some companies in the S&P 500 index report more than 100% of foreign sales for 2011, while others report zero.

S&P Dow Jones Indices diplomatically calls these “some of the ‘stranger’ values”, and eliminates them from its analysis.

“Investors need to be careful when determining what data and statistics to use,” the index provider says.

Two findings, however, seem undeniable – the trend of proportional sales is falling for Europe ex-UK, and rising for Asia. For Europe, the figures showed a drop from 12% of all sales in 2010, to 8.7% last year. In Asia, the portion rose from 1.9% to 4.3% over the same period.

For those US companies breaking sales geography down, 46.1% of all sales came outside of the US, down slightly from 46.3% in 2010, from 46.6% in 2009, and from 47.9% in 2008.

The index provider is not alone in criticising company reporting.

Deutsche Bank’s equity analysts point to the inability of statistics on paper to give a full picture of a company’s, or sector’s, financial health.

When assessing a company’s state of health, the bank’s Cash Return on Capital Invested (CROCI) team of global equity analysts also factors in ‘real world’ influences such as inflation, financial leverage, economic life, intangibles and goodwill, to move from an ‘accounting’ to an ‘economic basis’ for assessing companies and sectors.

They also employ relevant local currencies for plant, machinery and earnings of multi-jurisdictional companies; they apply discrete asset-specific depreciation schedules where necessary; and they bring back on-balance sheets items that companies have placed off-balance sheet.

 

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