Tuesday, 17 May 2016

Creative Accounting

There used to be a time when creating profits would require a real effort in hard work.

These days a much more simple way is available: call in the financial engineers.

I have written many times about the ways these people are able to polish up accounts.

In the tech world creativity to make profits out of thin air seems to have reached a whole new dimension.

Article from Bloomberg: Tech Startups Come Up With Some Creative Definitions for ‘Profitable’

Some snippets:

.... the startup [SpoonRocket] calculated that the business had become "contribution margin positive," meaning that it sells an item—in this case, pre-made meals delivered to customers—for more than the cost to manufacture, distribute, and sell it.

Uber said it was profitable in the U.S. and Canada during the first quarter of this year. Lyft said it is "on a clear and defined path to profitability." Postmates said it will be profitable by the end of 2017. DoorDash is "cash-flow positive" in some markets. TaskRabbit will be "profitable profitable" by the end of this year. It "won't be too long" until Airbnb is profitable. Instacart is "gross margin profitable." Luxe Valet is "on the precipice of being profitable" in some markets. At Y Combinator's demo day in March, many bright-eyed entrepreneurs clinched their pitches with a robust "and we're already profitable!"

Tech startups are increasingly touting a mix of less common financial metrics, even as their public counterparts move more toward generally accepted accounting principles. Amazon and Facebook recently began breaking out employee stock compensation in more of their results, bowing to pressure from regulators and investors. LinkedIn and Twitter still focus on numbers that exclude equity costs.

When Uber said it is profitable, the company similarly left out equity grants to employees, along with interest and taxes. Its main ride-hailing rival in the U.S., Lyft, declined to elaborate on its "path to profitability" statement, leaving questions about how or when it will reach its destination. Airbnb also declined to provide details on an executive's profitability comments. TaskRabbit said "profitable profitable" means it will turn a net profit but declined to say whether specific costs such as equity grants and taxes were included. Postmates, the courier service, used a profitability calculation that doesn't include taxes.

Several startups slice their numbers by markets to demonstrate financial maturity in certain cities or countries. Again, the criteria for what's included in those calculations can vary. Instacart told Bloomberg in February that it was profitable in its biggest markets and that 40 percent of its volume was profitable. The company later clarified that it meant gross margin profitable, which is usually limited to direct costs such as supplies and delivery labor. Instacart's calculation leaves out other costs, such as customer service, central office salaries, rent, and the cost of acquiring its workers. Instacart also said it is gross margin profitable, on average, across all its markets.

Luxe, an on-demand valet parking service, said it's currently profitable in some cities but declined to name them. The company defined "profitable in a market" as gross profit, excluding central operations costs. DoorDash, which delivers food from restaurants, said its cash-flow positivity is limited to its "earliest markets" and includes customer service and salaries of regional workers but leaves out central rent and operations.

However, at the end of the day, when the dust has settled:

"You can always say, 'We're profitable if we don't include X,' " Behr said. "But no matter how many ways you say you're kind of profitable, if your bank account ends up lighter than when you started—eventually, that doesn't work."

This is what Warren Buffett wrote in his last annual report (page 8, emphasis mine) about GAAP:

Though we sold no Kraft Heinz shares, “GAAP” (Generally Accepted Accounting Principles) required us to record a $6.8 billion write-up of our investment upon completion of the merger. That leaves us with our Kraft Heinz holding carried on our balance sheet at a value many billions above our cost and many billions below its market value, an outcome only an accountant could love.

It definitely seems that accounting these days is more of an art than a science. I am not sure if that is a good thing though.

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