Security Analysis and Business Valuation on Wall Street,: A ... - lib

The Limitations of Accounting Data 157navigates the ship, we are the ones who st<strong>and</strong> on the deck, who look for icebergs far<strong>and</strong> near, to the right, to the left, small ones, medium ones, big ones ...<strong>and</strong>warnthe office of the chairman well in advance to steer clear.” 4 Mr. Raines left the firmwith a $120 million severance package, even as the stock price fell 80 percent.The Balance SheetAssets Assets comprise many categories that present challenges in evaluating abusiness. This section begins with cash <strong>and</strong> continues through intangibles.Cash Stability Corporation can do little to inflate this account short of fraud. Afew firms have been caught commingling the operating cash account with dedicatedcash accounts (i.e., those set aside for lenders, l<strong>and</strong>lords, <strong>and</strong> other special parties).Marketable Securities Often aggregated with cash, marketable securities representhigh-quality, short-term debt obligations, such as prime certificates of deposit <strong>and</strong>commercial paper. In 2008, this conservative characterization came into questionwhen dozens of public corporations took write-downs. They had invested billions inspare cash in auction-rate securities that proved to have both limited liquidity <strong>and</strong>poor credit st<strong>and</strong>ing. For example, MIND CTI, Ltd., a growing software firm, wrotedown $20 million of its $30 million in cash <strong>and</strong> equivalents. Not one analyst caughtthe auction rate problem in advance.Accounts Receivable, Net of Reserves The receivables from many sales are notreflected at 100 percent face value. A reserve is established for the possibility ofnonpayment, returns, warranties, <strong>and</strong> other items. Of particular note are health careproviders, who frequently have a large number of nonpaying customers. HealthSouth had significant nonpayment issues prior to its billion-dollar restructuring.The proper level of reserves is a major issue for any finance company, whoseprincipal assets are loans <strong>and</strong> receivables from others. Auto lenders increased reservesin 2009 as difficult economic conditions hurt consumers’ repayment ability.Bad debt reserves are important issues with banks <strong>and</strong> insurance companies.The former’s voluminous bad debts cost the U.S. government billions during thesubprime crisis.As noted earlier, the counterfeiting of invoices has been used to jigger financialstatements. The analyst relies on the independent auditors to police this fraud,although a studied examination of receivables’ performance against revenue canpresent clues to such shenanigans.Inventories Fashion changes, product innovations, <strong>and</strong> technological advances canquickly reduce the value of a firm’s inventory. After the Internet boom, many Internetequipment suppliers endured sizable inventory markdowns. Dem<strong>and</strong> for theequipment dried up <strong>and</strong> selling prices fell. Cisco Systems’ charge-off was $2.2 billion.Inventory valuation is an ongoing challenge in the apparel <strong>and</strong> retailing industriesbecause of fashion changes.Not being experts in all products, many accountants have trouble identifyingdiminished value, so the analyst has to ask questions if inventories seem high byhistorical st<strong>and</strong>ards.