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02/12/2018
TRUSTING THE NUMBERS!
By: Ted Theodore
TRUSTING THE NUMBERS!

Before getting to the requirement for accurately forecasting the future, it is important to note that even the past record of earnings has serious challenges. In its lead article one year ago, the Financial Analysts Journal (January-February 2016) published “The Misrepresentation of Earnings.” […]

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Before getting to the requirement for accurately forecasting the future, it is important to note that even the past record of earnings has serious challenges. In its lead article one year ago, the Financial Analysts Journal (January-February 2016) published “The Misrepresentation of Earnings.”

The research was the result of a survey of 400 chief financial officers, and the findings are sobering. Fully 20% of earnings reports were felt by the respondents to be intentionally distorted and by a significant amount: 10%. In an age where “missing by a penny” causes great shock to the market, this is a serious finding. Further confirming the general nature of the distortions, about two-thirds were in favor of higher earnings.

Public companies are required to issue reports in compliance with “Generally Accepted Accounting Principles” (GAAP). While it sounds as if this standard would allow no wiggle room, independent accountants who certify these results cede fairly large degrees of discretion to management in important areas. As most businesses today have some degree of complexity, it is no surprise that there are innumerable occasions where interpretation of accounting entries can, legitimately, vary widely. Indeed, managements have reasonably great latitude and discretion in their recognition of revenues, expenses and balance sheet items. Most of the time (80%, according to the CFO survey) management does a straight-up job.

Certainly, management is not going to announce they have misrepresented their results. The prescription, from the CFOs themselves, is to rely specifically more heavily on the metric, “cash flow,” rather than earnings.

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