Always a Game

July 2006

Looking for My Lost Shaker of Salt

Financial and budgeting data can be manipulated. I know, you are shocked. Shocked!

What is supposed to be an objective measurement of an organization’s ability to manage its resources can be quite subjective. You need to view any financial disclosure of an organization with a grain of salt—and depending on how motivated they are to look good—with an entire shaker of salt!

Some accountants have even been known to enjoy the occasional lost weekend with Jimmy Buffet. Not Warren Buffet—Jimmy. You know—the Margaritaville guy.

Most accountants are involved in three types of measurement of financial results—financial statements, budgets, and performance metrics. Let’s look at each in turn to see how reliable the information is:

Financial statements—at least there is a standard

At least there is a standard for financial statements—standards that say what rules should be followed in creating and presenting the statements. These rules are called Generally Accepted Accounting Principles (GAAP). Auditors come in periodically to ensure that these rules are being followed.

If the financial statements are not audited, you can’t rely on them. You have no assurance that the financials follow GAAP and they could be complete fiction for all you know (please reference previous comment on lost weekend.)

Once I was teaching a state entity how to read the financial reports that they used to monitor their grants. During class, we reviewed a few actual reports from their grantees. At a glance, I could see major flaws in the financial statements; the balance sheet didn’t balance; the cash generated by operations was obviously inflated, etc.

The state didn’t require that the grantee’s financial statements undergo an audit—and so the grantees created junky financial statements.

Without an audit, the accuracy of the financial statements depends on the honesty and diligence of your general ledger accountants. Some finance departments are honest, well-oiled machines of accuracy. Some aren’t. Consider Enron.

The federal government became so freaked out by the Enron debacle that now all publicly traded companies must—in addition to undergoing an audit to make sure the financial statements follow the rules—undergo an audit to make sure that the finance department is honest and accurate. Ever heard of Sarbox? Sarbox is short for the Sarbanes-Oxley Act; the post-Enron, new federal law that requires super audits!

No standards for budgeting

Financial statements are about as good as it gets as far as standards. No standard exists for the look or usage of a budget document. And as such, the budget is a complete reflection of the culture of the organization and the preferences of your accountant. You don’t even have to have one, if you don’t want one.

Here are some questions I always ask to find out how seriously an organization takes budgeting:

• How frequently do you monitor the actual results against the budget?
• When the monitoring report highlights a variance—budget is different from actual—what do you do? Do you hold teams accountable? Do you revise the budget?
• What is your process for creating the budget? Do you include the folks that are held to the budget or is it a creation of the accounting department?
• How often do you create a new budget or projection?
• How is your organization sliced and diced into units? Do you use projects, departments, divisions, functions?
• How do you prevent managers from padding the budget or manipulating results? Why would a manager be motivated to manipulate results?

Strangely enough, plenty of organizations go through the exercise of creating a budget every year, but render it nearly useless by failing to hold managers to their projections.

Can these numbers be manipulated for the benefit of a few individuals? Can you even believe I asked such an obvious question? Of course they can. No doubt about it.

Performance measures can be completely made up

The GASB—the Governmental Accounting Standards Board—is about to make performance measurement mandatory for state and local governments. So, I expect that in the next ten years, we will have performance measurement for the public sector. (NOTE: What I expect and what I get often vary widely).

The public sector is free to report metrics any way they want. For instance, for a long time Dell loved the metric ROIC (Return on Invested Capital). They disclosed it every year in their annual financial report, right at the front of the document, because this number looked so good for them.

ROIC measures the profit (return) that is generated for the capital you invest (fixed assets plus working capital). In the six years of ROIC’s heyday at Dell (one of their analysts even had a Porsche with an ROIC license plate!)—ROIC rose from 30 something percent to 300 something percent.

No matter how I calculated it based on the financial data, the highest number I could ever come up with was in the high 30 percent. I couldn’t get it anywhere near 300 percent.

30 percent is remarkable and a metric that Dell could be very proud of. But, because there was no standard for the way it was calculated, they (presumably the Porsche man and his staff) came up with their own calculation of ROIC that added and subtracted plenty of figures that made ROIC even higher. After a few years—it was in the triple digits and eventually reached 300+.

Just about this time, the press was already beginning to make noise about how corporations manipulated financial data to appeal to their shareholders. Someone at Dell (not, I presume, the ROIC Porsche man) finally said—enough is enough. This has gone too far. Now ROIC is not featured in any of Dell’s financial reports.

Be wary, very wary, of performance data and metrics purported by corporations and governments. Because no standard exists today—and these types of figures are rarely, if ever audited, they should definitely be digested with that lost shaker of salt…

Some people claim that there’s an accountant to blame, but I know,
hell, it could be their fault…