[much snipped]
My criticism lies with the meaning that people are trying to derive from the financial statements - you can’t predict the future of a company based on a set of financials alone. To complain that valuation is unfair because it doesn’t take into account future earnings is wrong.
I agree that you can’t predict the future of a company from the financial statements in general. However, that is a non-sequitur. A succinct version of the argument: 1. The current value of an asset is subjective. 2. It isn’t accounted for as if that is the case. 3. That’s bad. It seems that you agree with 1 & 2 and disagree with 3. Is that a fair assessment? You also seem to be arguing against the additional point 4. Only the subjective value should be accounted for. The cost of the asset should be ignored. I am not making this point and also disagree.
Projected earnings go into financial statements all the time. This is true for valuation of many asset classes. So if it is wrong, then current accounting practices are wrong. You seem to assume that any confidence less than 100% is 0%. That’s bogus. The valuations aren’t just unfair because they don’t account for future earnings, they are wrong. Why is it wrong to complain? I’ve been responsible for producing earnings projections before for an asset purchase. I stated my assumptions and made a projection. I provided multiple scenarios. Why shouldn’t that analysis be disclosed? That directly impacts the value of an asset. Does the type of asset matter? If it’s a piece of machinery, it’s wrong, but if it is a company, it’s acceptable? From an information disclosure standpoint, why would you distinguish between them? Heck, certain assets can still be held off balance sheets. That effectively gives them a value of zero. Would you agree that completely hiding the value of an asset is bad disclosure?
Additionally, future earnings =/= accrual basis accounting. Accruals are based on actual income earned or costs incurred - there is a legally binding basis and verifiable source/subject related to the income or the cost. There is a huge difference between confirming accounts receivable and trying to claim that a machine will make $XX in the future. Accountants aren’t predicting the future with accrual-basis accounting - they’re simply reporting the aggregate result of the many, many exchange-based contracts into which a concern enters in the course of business.
Hey, you trying to sound patronizing here?… I’m aware of how accrual accounting works. I think my example is good. If a majority of the income comes in now and the goods are delivered, the whole purchase price is accounted for now. But just because something has a legal basis doesn’t make it correct or useful. In fact, there have been efforts to reverse the practice because it is misleading and has been used as the basis for fraud. Look at banks right now. Loans that haven’t received a single payment in over 90 days get to be classified as current with simple tricks. Securitized products were/are even worse. They were basically current until they were worthless. So I disagree, as far as useful information, there isn’t a big difference between confirming accounts receivable and claiming a machine will make $XX in the future. The only difference appears to be that one is legal and one is not.
The purpose of financial statements is to disclose information regarding the performance and status of the concern in the recent past. Are you arguing that this information isn’t useful? Would you rather go without knowing just how much a company sold, and how much of the revenues were in cash form versus credit form, and how much that last piece of giant machinery cost, and so on and so forth?
Why the heck would such information be one or the other? I said that cash-flow statements are useful. I think capital expenditure plans are useful. They provide information about where money was spent. This is good! It’s important to account for how money was spent and how money was earned. But current accounting doesn’t say anything about whether the money was spent well. If a machine was purchased in January and is being used in production today, that already has value. There isn’t even a future component to it. But that isn’t accounted for. That’s information in the recent past. It is ignored. That is a disservice to investors, but it also makes valuations incorrect.
The financial statements are not the end-all, be-all of the information an investor should be inspecting in the course of making decisions about where to place their funds. The financial statements are the most conservatively objective, reasonably materially accurate and relatively comparable-across-concerns report available regarding actual revenues/expenses, assets/liabilities, and cashflows. If this information is useless to you, then don’t look at it - but don’t complain because the financial statements aren’t dictating to you exactly whether a concern is a good investment or a bad investment.
Legally, financial statements are the be-all, end-all of the information an investor gets from a company. The statement that “The financial statements are the most conservatively objective, reasonably materially accurate and relatively comparable-across-concerns report available regarding actual revenues/expenses, assets/liabilities, and cashflows,” is objectively false. I don’t dispute the revenues/expenses (although I do have a beef with revenues in accrual basis accounting, which is legally required and, in my opinion, wrong) or cashflows. But the assets side of assets/liabilities is almost completely bogus.
Finally, you took that quote from the linked piece completely out of context. Why did you leave out the very next sentence, which totally negates the point you’re trying to make?
Well, that has a simple answer. I didn’t RTFA. I reblogged from QtC. I really liked the quote.
But I did go back and read the post. And I disagree with most of the argument provided. The author also seems to assume that only a single number can be provided for anything. This is flawed and insanely stupid. There’s absolutely no reason to make that assumption other than the fact that financial accounting has historically done so. What’s interesting is that accountants often take actuarial classes, and an actuary would argue for additional information.
But the author also incorrectly discounts the purpose of financial reports. Insofar as financial reports are required by the SEC, they are for investors, period. They concern the regulators only so far as they protect the investors. That’s in accordance with the SEC’s mission. If the tax man wants something different, the tax man can ask for something different. If creditors want something different, they can ask for something different. But if the SEC asks for something, it is information for investors.
In other words, I reject the author’s thesis and embrace his straw man. I don’t think he adequately argued his position.
