As quarterly performance review meetings with investors nears, every Chief Accounting Officer, Chief Financial Officer, and Controller starts thinking about forecasts and projections as this is also the time when targets and budgets are set in relation to the company’s next quarter.
In most countries, there is no rule and regulation that requires publicly traded companies to issue statements or provide information regarding their future financial position and performance. However, most companies around the world do provide its stakeholders with the earnings guidance. What makes accounting and finance executives uneasy and nervous is the truth behind the basis and assumptions they use while preparing forecasts and projections. Many finance and accounting professionals have confessed to using creative accounting techniques to make their entities appear more profitable.
No one has the power to predict the future. This allows finance teams/ departments to be extra-cheeky and creative when writing up the earnings guidance of their companies. In case, they are proven completely wrong or incorrect then they will most likely say that they made their best estimate based on a mixture of past trends, existing available information as well as assumptions about the future. This creates an issue for investors who want to trust that the forecast and projections provided by the companies are as close to perfect as they can be.
In majority of the countries, creative accounting techniques, for the most part, are legal. However, the knowledge that companies may be using creative accounting tactics to brighten the prospects of their companies is very disconcerting and alarming, especially from the perspective of the investors, to say the least. One don’t know as to how much are companies augmenting their financial performance and position and this is very concerning from the stakeholders’ perspective.
Many surveys in the past have highlighted that how concern and worried institutional investors are regarding companies using creative techniques to show better prospects and not the truth about their financial reality.
Many surveys conducted by reputable organizations as well as frauds and scandals at large corporations in recent times have suggested that some companies may be going way too far in showing prospects of better earnings through distorting financial information presented in forecasts and projections for forthcoming financial periods. Usually, the creating accounting techniques which most companies use includes decreasing depreciation charges, overestimating revenues, manipulating inventory, undervaluing pension obligations, and masking contingent liabilities, among others.
The question is why accounting standards and other related rules and regulations around the world allow this to happen. One main reason to explain all this is that accounting standards and other related regulations have loop holes, the advantage of which these large corporations take when using creative accounting to manipulate figures and information presented in their forecasts and projections. Enron’s finance department famously said that they never went against the rules, they just used the loopholes existed in those rules to their benefit.
Another reason as to why financial regulators and standard-setting bodies allow companies to use creative accounting techniques is existence of many different management systems that pump data/ information into the finance function from across the enterprise. Sometimes it becomes difficult for the accounts and finance team to match and reconcile the data as this requires them to match thousands of spreadsheets. For example, purchase invoices must be matched with purchase orders and goods received note. While, the payment of the purchase invoices must be traced in bank and credit card details. Bank records/ statements must be matched with the bank account appearing in the entity’s general ledgers.
The sheer complexity and time-consuming nature of these tasks is part of the reason as to why accounting bodies allow accountants and financial experts to make assumptions in their forecasts and projections.
Importance of Transparency
Fortunately, there are methods and ways to distinguish facts from fiction. A dose of professional skepticism when studying the earnings guidance allows one to be in the right state of mind to question the comments given by the company’s management regarding their future performance. Having Knowledge and understanding about the different creative accounting tactics that are used by most companies also helps in determining whether they are used in a projection or not.
Now the time has come to put the spotlight on creative accounting tactics that obfuscate the facts and serve no real purpose. Instead, companies should encourage their accounts and finance department to be strategically creative and leveraging their skills and experience when providing advice on how to actually increase revenues and reduce expenses.