We’ve all heard the expression that “cash is king.” This well-worn phrase often is used when assessing the financial health or investment prospects of a firm.  Those of you that have followed the Grumpies for a while, may recall a past rant on how companies increasingly “manage” reported cash balances and cash flows (see What’s Up With Cash Balances?).  In that diatribe, we described the games that global financial managers now play with cash to overstate performance, as well as the competence decline in entry-level accountants in the auditing and reporting of cash. Unfortunately, things have not improved during the past three years from either an academic OR a real world perspective.

First, the bad news from the classroom front.  A month ago, I surveyed my summer graduate students (Master of Accounting candidates) on their undergraduate accounting/auditing education in the area of cash.  These students, most of whom attended well-regarded bachelor degree programs, almost unanimously reported that their accounting instructors devoted little or no time to cash or related controls (e.g., bank reconciliations, etc.), and none had even heard of a proof of cash.  When it came to cash disclosures, the results were equally troubling.  None had ever been exposed to cash policy disclosures or the notion of restricted cash balances.  Obviously, cash is NOT king to some of my ivory tower accounting colleagues…

Surely, it can’t be this bad in the real world, right? WRONG!  The recent fascination with corporate inversions, transactions in which U.S. companies make overseas acquisitions to reduce their tax burden on income earned abroad, has drawn this grumpy old accountant’s attention to yet another potentially misleading disclosure…this time one associated with “trapped cash.”  Trapped cash generally refers to corporate cash balances held in wholly-owned foreign subsidiaries.

The Bigger Sin: “Trapped Cash” or Non-Payment of Taxes?

So what’s the problem? To avoid U.S. taxation of foreign income earned abroad, companies commonly assert that they have no intention of returning the “trapped cash” associated with foreign earnings to the United States.  Here are a couple of examples from three well-known tax minimizers:

The Company intends to reinvest these earnings indefinitely in its foreign subsidiearies.
— Cisco 2013 10-K
However, our intent is to permanently reinvest these funds outside the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations.
— Google 2013 10-K
As of June 30, 2013, we have not provided deferred U.S. income taxes or foreign witholding taxes on temporary differences of approximately $76.4 billion resulting from earnings for certain non-U.S. subsidiaries which are permanently reinvested outside the U.S.
— Microsoft 2013 10-K

My beef is not with their obvious and well-publicized tax avoidance practices, but rather that they report “trapped cash” balances as unrestricted cash in their consolidated balance sheets.  Clearly, such cash balances are not available for general corporate use as intimated by Google above, therefore the use of these liquid assets is restricted to the jurisdiction where the cash resides.  Consequently, restrictions on “trapped cash” and related assets should be reported in the financial statements, and 10Q and 10K disclosures expanded to enhance reporting transparency. 

But do companies clearly and fully disclose this restriction?  You guessed it…NO!  After all, such transparency would negatively affect their financial optics in at least two ways.  First, liquidity ratios would be negatively impacted if companies reported restricted “trapped cash” balances as non-current instead of current assets in the balance sheet.  Additionally, operating cash flows (OCF) might be negatively impacted by my proposed restricted cash treatment, since increases in restricted “trapped cash” balances would be classified as investing activities, NOT operating activities in the statement of cash flows.  Given that OCF are relied upon for a variety of valuation exercises (e.g., stock price calculations, impairment tests, etc.), the incentives for managers to ignore this restricted cash disclosure issue are clear.

Vincent Ryan summed up these disclosure risks nicely in Offshore Corporate Profits Pose Hidden Risks:

As they pile up in cash accounts, undistributed foreign profits are inflating U.S. multinationals’ valuations and making companies appear less leveraged...The growing profits earned by U.S. companies in foreign jurisdictions are in many cases sitting in subsidiaries’ bank accounts and are being rolled up into the parent company’s consolidated balance sheet, boosting overall reported cash balances.
— CFO.com, June 6, 2014

GAAP and “Trapped Cash”

So what do generally avoidable accounting principles (my definition of GAAP) say about this issue?  Not surprisingly, very little. ASC-305 is generally silent on the restricted cash issue but does cite Securities and Exchange Commission Regulation S-X, Rule 5-02.1 as a resource for restricted cash disclosure.  According to the SEC (key points highlighted):

Separate disclosure shall be made of the cash and cash items which are restricted as to withdrawal or usage. The provisions of any restrictions shall be described in a note to the financial statements. Restrictions may include legally restricted deposits held as compensating balances against short-term borrowing arrangements, contracts entered into with others, or company statements of intention with regard to particular deposits; however, time deposits and short-term certificates of deposit are not generally included in legally restricted deposits.

For the “trapped cash” issue, Rule 5-02.1 seems clear and on point.  Given the stated intention of corporate tax minimizers NOT to repatriate earnings or related assets, clearly the cash is restricted.  Foreign subsidiary cash balances should be reported in a separate balance sheet account, and the nature of the restriction disclosed in a note to the financial statements (not just a one-liner buried in the 10-K management, discussion, and analysis).  And remember, removing these restricted cash balances from cash and cash equivalents will also affect reported OCF!

Scope of the “Trapped Cash” Problem?

As the following table for 2013 (prepared in millions and based on firm 10-K data) suggests, for at least five global technology companies the “trapped cash” disclosure problem (and repatriated earnings issue) is far from insignificant.  Note that all of the companies reported cash and cash equivalents lumped together with short and long-term marketable securities.

Apple has by far the largest amount of total cash and securities “restricted” to its foreign subsidiaries at $111.3 billion (75.84 percent of total cash and securities and 53.77 percent of total assets).  However, both Oracle and Microsoft report cash and security balances where over 90 percent are “held” in foreign subsidiaries.  Of the five companies, only Oracle discussed the “trapped cash” issue in the cash policy note to its 2013 10-K:

Cash, cash equivalents and marketable securities included $35.2 billion held by our foreign subsidiaries as of May 31, 2014. We consider $32.4 billion of our undistributed earnings as indefinitely reinvested in our foreign operations outside the United States.
— Oracle 2013 10-K

Surprisingly, two companies (Apple and Microsoft) report that approximately half their total assets (53.77 percent and 48.87 percent, respectively) are cash and securities held in foreign subsidiaries!  Maybe a “restricted asset” disclosure is in order…just a thought.

And that’s not all…let’s not forget that a reclassification of “trapped cash” to a non-current asset classification will impact OCF.  Three of the five companies discussed above (Apple, Google, and Oracle) may have potentially overstated their 2013 OCF due to increases in “trapped cash” during the past fiscal year.  If we apply the percentage of total cash and securities held in foreign subsidiaries (from the above table) to total reported cash and cash equivalents, we can estimate the cash held in foreign subsidiaries at the end of 2013 and 2012.  The below table reflects these assumptions.

Increases in “trapped cash” cannot be considered operating inflows due to their restriction.  Therefore, they are really investing cash inflows.  Consequently, any increase in “trapped cash” should be reversed out of reported OCF.  The above table suggests fairly significant possible overstatements of OCF for these three companies.

Are Current “Trapped Cash” MD&A Disclosures Enough?

Not if transparency is the goal!  Investors need much more information about the nature and scope of this cash restriction, and its potential impact on liquidity and OCF.  At the very least, increased disclosure would eliminate our need to estimate the impact of “trapped cash” on the balance sheet and statement of cash flows.  So here are a couple of grumpy suggestions on how to improve transparency:

  1. Eliminate manager incentives to play the “trapped cash” and “unremitted foreign earnings” games.  Yes, that will require some significant tax law changes, which in turn requires that our Congress works together.  Well, I guess you can scrap this idea…what was I thinking?
  2. The SEC should be more aggressive in enforcing registrant compliance with Regulation S-X, Rule 5-02.1.  Specifically, companies should reclassify their “trapped cash” balances into non-current asset restricted cash categories in their balance sheets.  Also, the SEC is clear that restrictions must be described in a note to the financial statements, not simply buried in the MD&A.  And of course, the statement of cash flows would require that any changes in “trapped cash” be reported as investing cash flows.
  3.  Finally, for companies with significant “trapped” cash and securities balances, the SEC should consider expanded MD&A disclosures that provide detail on cash and security balances by category, as well as unremitted earnings, by foreign jurisdiction.

So, there you have it.  While cash may indeed “be king,” the “trapped cash” disclosures of large global companies are far from royal.  The sad truth is that there is no good reason why cash reporting has to be this complex, if we could get our tax house in order.  Perhaps Kurt Vonnegut said it best:

Here we are, trapped in the amber of the moment. There is no whay.

This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.

AuthorAnthony Catanach
3 CommentsPost a comment

I thought bunnies were supposed to be cute and cuddly little creatures?  Well after looking at Annie’s, Inc….maybe not.  This Company has recently “hit the trifecta:” a restatement of its financials (2014 10K, p. 54), a material weakness report on its controls over financial reporting (2014 10K, pp. 45 and 74), and an auditor resignation (2014 8K dated June 1)…all in the space of a week.  And if this weren’t bad enough, along comes a class action suit alleging false and/or misleading financial statements and disclosures.

But should we really be surprised.  No, not really since until this year the Company avoided scrutiny of its accounting and controls via its JOBS Act status as an “emerging growth company”(2014 10K, p. 32).  It has been less than a year since I reminded you in Garbage In, Garbage Out – Are Accountants Really to Blame? that:

Proponents of “emerging-growth” company (EGC) internal control reporting exemptions claim cost savings that promote business development. The reality is that most ECGs simply have no internal controls.

So, did PricewaterhouseCoopers (PwC) really dump Bernie, Annie’s mascot, just over a restatement and some internal control weaknesses?  After all, there’s many a PwC client that has committed far greater sins and still remained a client of the firm (hint: Financial Crisis of 2007 and 2008).  Just how could PwC disapprove of Bernie, Annie’s “Rabbit of Approval?”  This is just the kind of question this grumpy old accountant likes to tackle.

Management Under Fire

Given recent allegations made in the class action suit filed in United States District Court, Northern District of California, and docketed under 3:14-cv-03001, it seems reasonable to first investigate whether Annie’s management had any incentives to engage in inappropriate financial reporting behaviors.

Clearly, management experienced significant pressures to report positive performance results.  The following factors individually and collectively may have created demands to engage in aggressive financial reporting:

The Company’s history of operating losses as evidenced by its retained earnings deficit (2014 10K, p. 47)

  • The recent rapid growth in profitability despite declining gross profit percentages (2014 10K, p. 34)

  • Restrictions imposed by credit agreements (2014 10K, p. 22)

  • The steady decline in the Company’s stock price per share from a high of $51.36 on November 15, 2013 to its current price of 33.14 (a decline of over 35 percent)

  • The role of stock based rewards in management compensation (2014 10K, pp. 63-65)

And all of these hurdles had to be addressed in a highly competitive market (2014 10K, pp. 9 and 12). 

Could the Company’s operating environment contribute to or facilitate inappropriate financial reporting by management?  The recent negative report on internal controls over financial reporting would seem to suggest so.  Acknowledging “an insufficient complement of finance and accounting resources” (2014 10K, p. 74) is a fairly damning admission for any organization, much less a publicly-traded company.  The statement suggests an environment devoid of controls and oversight…one just perfect for aggressive financial reporting.  And contrary to managements’ assertions, there is no quick fix to this problem.

Then, there is the issue of key officer turnover at Annie’s.  Amanda K. Martinez joined the Company as Executive Vice President in January 2013 (2013 8K dated January 5), was promoted in December 2013 (2013 8K dated December 9), and resigned without a stated reason in March 2014 just prior to the end of the fiscal year (2014 8K dated March 26).  Also, the Company’s previous chief financial officer, Kelly J. Kennedy, resigned effective November 12, 2013 and was succeeded by Zahir Ibrahim on the following day (2013 8K dated October 16).  Such changes in the C-suite can wreak havoc on internal controls, and potentially negatively affect financial reporting.

So, is there any quantitative support for my qualitative concerns about the quality of Annie’s financial reporting? Absolutely!  Let’s first see what the Beneish Model reveals about the likelihood of earnings manipulation by the Company’s management. 

Using inputs from Annie’s 2014 10K, the Beneish Model reveals only a slight probability of earnings manipulation driven primarily by the rapid increase in sales and disparity between operating income and operating cash flows (OCF) (i.e., accruals).  More on OCF shortly.

The Conservatism Ratio also provides some evidence of aggressive revenue recognition.  This metric compares reported GAAP income before taxes with an estimate of an entity’s taxable income (current taxes payable divided by the effective tax rate). Generally, a ratio approximating one suggests relatively conservative income recognition practices, while those larger than one may signal increasingly aggressive revenue recognition practices.

Coupled with the Company’s rapid growth in sales and profitability, and the aforementioned apparent disconnect between operating income and OCF, the Conservatism Ratio seems to confirm concerns about aggressive revenue and expense recognition practices.

But there’s more…the Company’s financial reports raise additional questions for investors about accounting quality and transparency and provide more clues to PwC’s recent departure.

Transparency Failures

Non-GAAP Metrics

By now you all know how I feel about non-GAAP metrics.  So, why does the Company feel compelled to rely on flaky pro-forma disclosures when its GAAP numbers look so good?  Selected financial data (2014 10K, p. 28) reports a history of increasing net sales, gross profits, income from operations, and improving Earnings Per Share (for the last three years), and the statement of cash flows (SCF) reports dramatic annual increases in OCF (2014 10K, p. 49).  And the Company uses pro-forma reporting not just for EBITDA but for net sales and gross profit as well.  Particularly troubling are the nature if its non-GAAP adjustments which go well beyond those witnessed even in the case of Black Box, and include product recall adjustments, plant (not business) acquisition costs, secondary offering costs, management fees, and fair value changes (2014 10K, p. 29 note 3).

And note how the Company justifies these metrics (10K, 34):

We believe these non-GAAP figures provide additional metrics to evaluate our operations and, when considered with both our GAAP results and the related reconciliation to the most directly comparable GAAP measure, provide a more complete understanding of our business than could be obtained absent this disclosure.
— 2014 10K, p. 34

Yet, only four sentences later, Annie’s warns us that their non-GAAP metrics are of limited usefulness due to non-comparability:

Our computation of these non-GAAP figures is likely to differ from methods used by other companies in computing similarly titled or defined terms, limiting the usefulness of these measures.
— 2014 10K, p. 34

Who’s writing and reviewing this stuff?  I think we know the answer…no one…that’s what a material weakness in internal controls is all about.

Revisions, Restatements, and Errors

Where would you expect to find a detailed discussion of material accounting errors requiring a restatement of a Company’s set of financial statements?  This Grumpy Old Accountant can tell you that creditable, transparent companies report such things in a separate note with an appropriate title to highlight the event.  Not Annie’s…their error corrections are “buried” at the very end of note 2 (2014 10K p. 54) and labeled with the responsibility-avoiding caption of “revision.”  This behavior speaks volumes.

Adequacy of Allowances and Reserve

We know that the Company has booked some allowances by looking at the tax note for deferred tax assets (2014 10K, p. 69).  The Company reports total reserves and allowances related to temporary differences of approximately $1.2 million (tax effected), suggesting recorded GAAP allowances of approximately $3.5 million if adjusted using the federal statutory tax rate.  Annie’s reports no allowance for uncollectable accounts (2014 10K, p. 52), and discloses no inventory obsolescence reserves despite recent inventory write-offs (2014 10K, pp. 35 and 36). So, to which assets do the “reserves” listed in the tax note relate?  Once again, transparency and disclosure adequacy is an issue.

Sustainability of Reported Operating Cash Flows

The Company’s limited discussion of cash flows from operating activities (2014 10K, p. 39), makes no mention of the fact that the current year increase in OCF over the prior year resulted primarily from account receivable declines (i.e., an $8.012 million swing from $7.580 million of increases receivables to a $432 thousand decrease).  Does this make sense for a growing company?  And let’s not ignore the fact that 2013 OCF were driven significantly by increasing liabilities.  This weak disclosure’s lack of transparency makes one wonder what the Company’s real OCF look like.  So, let’s take a peek.

I “normalized” Annie’s reported OCF by adjusting for unusual or exceptional changes reported in the Company’s statement of cash flows (operating section only) during the past three years.  When one restores the operating section of Annie’s statement of cash flows to more “normal” activity levels, we find that OCF range between $8.6 million and $10.8 million over the past three years, are far cry from the soaring GAAP OCF reported in the 2014 filings.

Given Annie’s infatuation with non-GAAP reporting, let’s explore the changes and related differences in a schedule that actually provides some insight!  As shown above, in 2012, the Company’s OCF were abnormally low due to payment of unusually high amounts of accounts payable ($9,499). These “excess” payments were added back to OCF.  In 2013, reported OCF were impacted in opposite directions by stock option tax benefits ($8,113), as well as unusually high liability accruals ($8194). So, both of these were reversed even though the amounts almost offset each other. And in 2014, the Company liquidated its accounts receivable ($432), an interesting strategy for what is presumably a “growth” company. In this latter case, I assumed that the 2013 receivable increase was more appropriate for 2014 rather than the reported decrease.  Not surprisingly, my adjustments reveal a much different picture of the Company’s OCF. The soaring increases reported in OCF are gone, replaced by more modest, stable amounts that reflect a declining trend when compared to asset increases over the past three years.

The Goodwill Mystery

Also very troubling is that Annie’s provides little discussion as to the source of its reported goodwill other than it came from “prior acquisitions”.  Why were excess purchase prices paid and for what acquired assets?  Goodwill represents almost 30 percent of the Company’s balance sheet at FYE 2014 yet we have no idea of what it represents.  And given the Company’s admitted material weaknesses in controls over financial reporting, how can we have any confidence that goodwill impairment tests are even believable?  Given the impact of goodwill on the balance sheet and my declining ratio of normalized OCF as a percent of assets, one can’t help but wonder if an impairment charge is looming.

And that’s not all on the goodwill front.  How can goodwill be allocated to the purchase of a plant facility (2014 10K, p. 70)?  The Company provides no indication in note 18 of its financial statements that the Joplin snack manufacturing plant purchase was a business acquisition. 

Hopefully, by now you have a better idea why PwC abandoned this not-so-cute BNNY…a myriad of accounting issues, internal control problems, performance pressures, and non-transparent financial statements.  And let’s not forget that the NEW CFO blessed these financial reports (2014 10K, p. 78).  Toss in the threat of a little litigation and Bernie looks a lot less harmless. Good call PwC!

This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.

AuthorAnthony Catanach

With all of the bad weather here in the East, this aging number cruncher has had his hands full with scraping and shoveling. But I just had to take a break and comment on Twitter’s recent Form 8-K (February 5, 2014), particularly given the Company CEO’s comments last Fall on the importance of transparency to being a good leader.

According to Kurt Wagner of Mashable, CEO Dick Costolo said the following about transparency at a TechCrunch Disrupt event last September:

The way you build trust with your people is by being forthright and clear with them from day one. You may think people are fooled when you tell them what they want to hear. They are not fooled. As a leader, people are always looking at you. Don't lose their trust by failing to provide transparency in your decisions and critiques.

Well, when you go “on the record” about one of my favorite themes, I just had to give Twitter’s 8-K a look. And what did I find? Apparently, Twitter’s CFO does not share the same transparency philosophy as his boss.

But before I begin, I thought it useful to report on the accuracy of some predictions that I made about Twitter’s financial performance before the Company’s IPO. In “What Will Twitter’s Financials Really Tell Us?”, I took a shot at forecasting the Company’s post-IPO balance sheet using a comp group consisting of Facebook, Sina Corp, Yelp Inc., and Meetme Inc. And while the average revenue to assets percentage for this comp group (46.84%) yielded total assets of only $1.3 billion instead of $3.4 billion, the forecasted balance sheet category percentages were quite close as illustrated in the following table:



My comp analysis forecasted the high levels of cash and short-term investments and stockholders’ equity reported by Twitter, and was almost spot on in predicting other current assets, net PPE, and other intangibles. However, my predictions for goodwill were a bit off the mark.

As for the income statement, I expected operating losses (no surprise there), but nothing close to the $645 million reported by Twitter for the 12 months ended December 31, 2013. And of course, I predicted the Company’s use of non-GAAP metrics to transform poor performance into “a great year” as noted by CEO Costolo (Exhibit 99.1, page 1). Sure enough, Twitter converted its over half a billion dollar net loss into an Adjusted EBITDA of $75.4 million by deducting over $600 million in stock-based compensation from EBITDA.

When it came to operating cash flows (OCF), I expected either negative or transitory numbers, and the Company delivered exactly that: an anemic $1.4 million in OCF driven largely by the non-payment of accounts payable and increases in accrued and other liabilities. So, basic market multiple analysis did a decent job painting us a picture of Twitter’s post-IPO primary financial statements.

Then, there was my rant about the Company’s cost structure in “Twitter’s S-1: More Social Media Company IPO Drama.  As you may recall, I used the High-Low Method of Cost Estimation to calculate a breakeven sales point of $639.5 million for Twitter.  Well, guess what?  Had the Company not expensed $600 million for stock-based compensation (an increase of $575 million over the prior year), this prediction would have come close to being reality.  Actual revenues which approximated $665 million yielded an adjusted net loss of $45.3 million (actual net loss of $645.3 million less stock-based compensation of $600 million).  So again, fundamental cost estimation tools can provide insights even for social media companies.

But back to the transparency of Twitter’s recent 8-K. What really stirs me up this time is the Company’s blatantly positive spin to the exclusion (or minimization) of anything negative.  For example, quarterly and annual revenue increases are reported, but little or nothing on costs.  And when losses are reported, they are accompanied naturally by non-GAAP numbers that paint a much rosier performance picture.  What about some real operating data?  After all, Twitter devoted a whole page to non-GAAP metrics (Exhibit 99.1, page 8)! Could it be that real operating data highlights some "chinks in the armor?" The following table raises some questions about the Company, its business model, and its management:

Operating Data Chart.jpg

Of particular concern is the slowdown in growth in the Company’s revenues over the prior year (almost 200% growth in 2012 and only 110% for 2013). Also of interest are the declines in several key percentages: operating assets to total assets and revenues to operating assets.  And if we buy into the validity of adjusted EBITDA, note that the ratio of adjusted EBITDA to operating assets increased only about 1.5% during the past year, despite a 178.4% increase in operating assets during the same period.  What are those operating assets contributing?  Well, it’s definitely not OCF, as OCF to revenues totaled only .21% for 2013.  I am not sure that I buy into the “great year” description of CEO Costolo.

And why doesn’t the Company tell us about its cost problems? I’d gladly swap the non-GAAP metrics page for some insights into why costs increased over 230% from the prior year. Yes, earnings were adversely affected by over $600 million in stock-based compensation, but that raises another question? Given this type of performance, were these “rewards” really earned and warranted? And this wasn’t just a one-time pop…the 8-K indicates that next year’s stock-based compensation will be just as large (Exhibit 99.1, page 3).

If we adjust the Company’s operating expenses for stock-based compensation and amortization of intangibles, some interesting insights about Twitter’s business model (or lack thereof) surface.

Operating Expense Adjusted Data.jpg

Without stock-based compensation and intangible amortization, total costs and expenses still increased at a whopping 95.6% rate.  Although this represents a slight decline from the prior year (12.2%), the decline is much less than the revenue decrease for the same period (88.3%).  And as the above table shows, this year’s increase was driven primarily by continued triple digit R&D spending, and sales and marketing, suggesting that the Company’s business model is still ill defined and in flux.

And as I pointed out in “Twitter’s S-1: More Social Media Company IPO Drama,” goodwill and intangible asset valuations are more questionable than ever given the Company’s operating losses and anemic OCF.  Then, there’s the issue of potentially unrecorded liabilities for contingent consideration associated with the Company’s recent acquisitions.

So will Twitter address these financial reporting and operating concerns in its next quarterly or annual report? Probably not…why should management tackle these tough questions, when the answers just might jeopardize the Company’s share price? On the other hand, didn’t CEO Costolo preach transparency just a couple of months ago? Or is this just another case of “do as I say, not as I do?”

AuthorAnthony Catanach
2 CommentsPost a comment

If your goal in getting a college business degree was simply to get a “job” with the least effort expended, stop reading now!  But if you were serious about learning the fundamental skills needed to support a long-term professional career in business, including a life-long learning perspective, your passion and zeal just may not have been enough according to a number of recent articles in the popular business.

Some suggest that college in general should be questioned.  Glenn Harlan Reynolds, a University of Tennessee law professor, encourages parents and students to “be skeptical” about the value of college.  With average student debt exceeding $29,000 and 40 percent of college graduates taking jobs that don’t require a college degree, he suggests that:

America's higher education problem calls for both wiser choices by families and better value from schools.

It’s hard to disagree with this statement particularly when so many parents and students conduct more due diligence in a car purchase than selecting the “right” college or university. 

Reynolds also notes that the value proposition for a college degree is frequently obscured by the “bait and switch” tactics increasingly used by administrators, as well their lack of budget transparency.  Many schools now routinely “outsource” class instruction to low-paid adjuncts to cut costs (and let’s not even get into on-line “classroom” initiatives), and it is next to impossible to see where one’s tuition dollars actually are being spent (e.g., administration, athletics, research, or teaching).

And guess what? Surprise…surprise…many employers now are questioning the skills of today’s graduates. Richard Vedder and Christopher Denhart from Ohio University confirm that:

Declining academic standards and grade inflation add to employers' perceptions that college degrees say little about job readiness.

They argue that the numbers just don’t work when college degree benefits are questionable and college costs are increasing. And the narrowing gap between what college and high school graduates earn particularly concerns them.  As an old jarhead, I found one of their statements particularly telling:

We now have more college graduates working in retail than soldiers in the U.S. Army, and more janitors with bachelor's degrees than chemists.

But what about business degrees specifically?  Dan Kadlec, a journalist for TIME, believes that:

Colleges are minting money-focused graduates in a work world that increasingly values critical thinking and softer skills like the ability to communicate.

Melissa Korn of the Wall Street Journal reports that “undergraduate business majors are a dime a dozen” and “may be worth even less,” since more than 20 percent of undergraduates in the United States are business majors. And graduate business education doesn’t get a free pass either. John A. Byrne, a contributor to CNN Money, documents the case of Josh Kaufman who believes that MBA programs “teach many worthless, outdated, even outright damaging concepts and practices.” 

Still not convinced that there just might be a flame or two behind all this “smoke,” then just take a look at look at Lynn O’Shaughnessy’s number one reason why NOT to get a business degree: business majors don't learn much in business school!  Her conclusion was based on Academically Adrift, a bestselling book that finds that business majors are among the students who learn the least in college. 

All of this negativism makes this Grumpy Old Accountant seem absolutely cheery doesn’t it?  Well, I must confess that my recent interactions with experienced business graduates (both at the bachelor and master levels) employed as accountants, analysts, managers, and reporters have raised more than a few doubts in my own mind. So, I decided to create a short, five question test (no accounting included, I promise) that administrators, current students, faculty, and recent graduates may find useful for assessing the effectiveness of their B-school experience.  And it’s no coincidence that the five questions mirror the major themes routinely discussed today by business academics and professionals alike. Being naturally grumpy, this exam is a closed book, closed note, essay test that should be completed with no outside assistance…what did you expect?

Question One: What is a business?

Believe it or not, many B-school graduates cannot answer this query in a clear, concise manner.  Often, the response is a long-winded, rambling summary of discrete topics that parallel course requirements that fails to accurately capture the essence of today’s enterprises. To receive full credit, the answer should be close to the following:

 A business is an economic entity that creates wealth (e.g., value, cash flow, etc.) by using financial, human, and physical capital to deliver products or services that the market demands.

And if you really want to wow this old prof, throw in a bit of the “nexus of contract theory” to motivate the need for information to monitor the various contracts which companies execute with shareholders, employees, suppliers, customers, debtors, and the like.

Question Two: What is business strategy?

So, once you decide on a business, what’s the strategy? The answers commonly received to this question are particular disturbing in that they refer to assorted permutations of action plans and related documents.  Sorry, just not specific or good enough. To receive full credit, the answer should address two key issues:

Business strategy is how an organization creates value for its customers and differentiates itself from competitors in the marketplace.

Value creation and differentiation must be addressed in every good strategy whether it be for a company as a whole, or each individual operating unit.  This short definition specifically focuses managers on their markets and customer needs.  If customers don’t value a company’s product or are indifferent to it vis-a-vis that of the competition, the company is unlikely to succeed in the long-run, regardless of its stated “strategy.”  If you add some verbage about Michael Porter’s Five Forces model in your differentiation discussion in the context of today’s technology dominated world, you will bring a smile to this Grumpy Old Accountant’s face.

Question Three: What is a business model?

This dot-com era buzzword can generate some very interesting definitions which provide great insight into what has been learned (or not) in the B-school.  Frequent responses include a business idea, an overly-complicated financial model, or a business plan.  These answers don’t even warrant partial credit!  So what is it?

 A business model describes how the pieces of a business fit together as a system to execute the firm’s stated strategy.

Every business model whether it be for the whole entity or each individual operating unit must address ALL of the following fundamental “value chain” activities: market analysis, product development and design, sales and marketing; procurement, production, and distribution, and after sale customer service.  How do each of these activities contribute to strategy execution?  Answer that and now you have a business model!  And some references to “How to Design a Winning Business Model” by Ramon Casadesus-Masanell and Joan E. Ricart will likely get you some bonus points.

Question Four: How should a business evaluate its performance?

As an accounting professor, I find the answers I often receive to this question to be downright depressing: stock price appreciation, revenue growth, earnings per share, and a host of other financial statement driven metrics.  These might earn some partial credit, but if you even hint at “adjusted EBITDA,” you get a zero.

Answering this question requires getting Question Three correct!  To evaluate performance you must have something concrete to measure.  In the case of a business, it’s how each of the five value chain activities that comprise a firm’s business model are performing.

A business should measure its performance by monitoring the implementation, execution, and effectiveness of its entire business model.

This means that managers need both financial and non-financial metrics to judge their market analysis, research and development, selling and marketing, production and distribution, and customer service activities.  Unfortunately, all too often, companies rely almost exclusively on financial statement numbers to do so.  The best answers to this question will be organized around Kaplan and Norton’s Balanced Scorecard framework.

Question Five: What role does innovation play in business today?

Historically, business innovation has been equated primarily with the development of new products and new technologies.  But as Birkinshaw, Bouquet, and Barsoux suggest, “products and services represent just the tip of the innovation iceberg.” So, a few points might be awarded for this weak “common sense” response.  But to receive full credit, respondents must have scored well on Questions 3 and 4. The following represents a more complete response:

Business innovation refers to any ideas and/or actions that can positively transform any part of the business model or its individual value chain activities, as well as the development of new products or service offerings.

The implications of this question are clear…to innovate, one must clearly understand the business model (Question 3) and how it is performing (Question 4).  The best responses will refer to the work of Clayton Christensen who distinguishes between disruptive and sustaining technologies.

There you have it.  Five grumpy questions that provide huge insights into the quality of one’s B-school education experience.  And these questions apply to all majors at both the graduate and undergraduate levels!  Students of accounting, economics, finance, information systems, and other business concentrations all must be able to address these fundamentals in order to apply their “specialized” knowledge effectively.  If none of the above material sounds familiar, get a refund on your business degree, as it has indeed failed you!  All of these themes should have been integrated and reinforced in every one of your classes.

But there is one other possible explanation before you file that refund claim.  Maybe the blame shouldn’t be assigned exclusively to the educational institution.  I tend to agree with Michael Sloan, a Wake Forest assistant professor, who concludes that our current educational predicament “is problematic for a citizenry whose attention span is as thin as the phones in our pockets.” His comments on our society’s apparent work ethic today are particularly compelling:

We forsake the mountaintop because getting there is too hard, and after time we believe all the world is a valley.

This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.

AuthorAnthony Catanach
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It’s the last week of the calendar year, and much of the accounting world is abuzz. Corporate accountants are putting the final touches on the those revenue accrual entries that will ensure that their company’s earnings will meet analyst expectations.  Global accounting firm auditors are completing audit “hand waving” exercises to justify their client’s optimistic balance sheet valuations and earnings increases.  And accounting standard-setters continue to avoid meaningful solutions to significant reporting problems including revenue recognition, lease accounting, and goodwill valuation, just to name a few.  What do grumpy old accountants do you ask?  This one tilts at windmills… 

It’s only been three months since I expressed displeasure with recent hype about what characterizes great CFOs today (see “Ten Commandments” for Today’s CFO), and nine months since I ranted about innovative performance metrics that were anything but (see “Innovative Performance Metric or Marketing Spin?”  Well, the business press is at it again with an article in the Wall Street Journal (WSJ) CFO Journal titled “ModCloth CFO: Four Metrics That Mean More Than Money,” penned by Jeff Shotts, ModCloth’s CFO.  The “innovative” measures this time are engagement, relevant user generated content (UCG), underserved market signals, and the ratio of rules broken to rules followed.  These four non-financial measures purportedly “power a high return on investment,” but instead are quite superficial, ill-defined, and clearly qualify as MBA speak.  What’s my beef this time?  ModCloth’s CFO fails my transparency standard (Commandment No. 6) , and is close to violating my “real” performance measurement criteria (Commandment No. 7).  Also, as someone who has clearly crossed the threshold of geezerdom, I have no patience for those selling something as “new and innovative,” when it is not.  Not a good start at all at being a great CFO!  So, let’s dig in…

My biggest disappointment in this article is the CFOs suggestion that some performance metrics “can be” more important than others.  This completely ignores the basic principles outlined in the widely-used, and time tested Balanced Scorecard planning and management system.  Performance metrics are supposed to provide evaluation data on different aspects of an organization’s operations (financial, customer, process, and learning and growth).  So, if you decide to measure something, presumably this dimension is important in its own right.  

It also is interesting that the four key metrics touted are all non-financial in nature.  I am not surprised at all that financial measures are ignored by the ModCloth CFO. Since ModCloth is still a young, private company, presumably focused on growth, the financial metrics are likely not very flattering (i.e., operating losses, negative cash flows, etc.).  In fact, I bet the Company’s senior leaders and investors regularly shrug off the financial metrics as not being representative of the great things happening in the organization.  Could “adjusted EBITDA” be far behind?  

But what about measures that provide insight into how ModCloth’s business model is performing ?  Only one of the four non-financial metrics (i.e., UGC) appears to directly relate to even one of the Company’s five value chain activities.  And then there’s learning and growth?  How are ModCloth’s investments in its people and technology performing?  How are these being evaluated?  But enough on what was NOT discussed in this article. Let’s take a closer look at the customer-based measures about which ModCloth’s CFO is so passionate.


ModCloth’s CFO defines engagement as user actions that have been proven to increase the average lifetime value of a customer and drive powerful solutions to otherwise intractable business problems. He concludes that:

The more engaged your customers are, the more value your business can create and the more flexibility your business will have to solve problems in a unique and differentiated way.

What an insight!  Customer relationships matter and longer, more engaged customers are particularly valuable…I am simply stunned that this is something that should be measured…NOT!  Don’t most retail businesses routinely recognize this through their use of loyalty programs, discounts for multiple service subscriptions, and the like?  

What troubles me most about this so called metric is how this CFO measures engagement. His threshold for achieving engagement is quite low, as simply signifying that you “like,” “love,” “share,” “review,” or “endorse” constitutes engagement.  Sorry, without an actual sales transaction, I would argue that he is really capturing technology usage, or interest…not consumer engagement. Yes, hopefully this consumer interest will ultimately lead to a purchase transaction, but ultimately it’s a sale that confirms engagement.  At best, this “interest metric” is a leading indicator.  However, this grumpy old accountant understands why this CFO measures customer engagement this way particularly in an online environment…absent actual sales, his engagement (and growth) numbers are going to look much better than the sales numbers. And this is likely going to be a big deal as ModCloth plans its inevitable IPO. Imagine if “brick and mortar” retail companies measured and reported customer traffic through their outlets as engagement…I am quite sure those numbers would dwarf retail sales.

User Generated Content (UGC)

The MBA-speak term UGC refers to nothing more than after-sale customer feedback that the Company captures and uses to improve the sale and marketing of its products. Again, after-sale customer feedback has been a key business model component for decades, so there is nothing new here.  Should I be troubled that ModCloth’s CFO thinks this is something to write home about?  Could there be other business model components that this on-line Company is missing or not addressing adequately?

 Signals from Underserved Markets

This purported metric is NOT a measure, but rather data collected from a number of “tried and true,” traditional, customer-focused performance evaluation tools.  And once again, ModCloth’s CFO serves up yet another marketing gem:

If you have direct connections with your customers and listen well, they will tell you when you have the potential for a break-through offering in the market.

Imagine…listening to your customers and observing their behavior pays off!  Who would have thought?  And what media does this CFO use to collect this consumer data…nothing that we haven’t been using for decades: surveys and interviews.  And of course, being an online retailer, there’s also the data gleaned from the aforementioned customer product reviews (i.e., engagement), and Facebook posts.  Particularly surprising is that this CFO admits to learning the value of customer feedback from his eBay experiences, rather than his MBA program…hmmmnn.

Ratio of Rules Broken to Rules Followed

ModCloth’s CFO concludes his article, not with an actual performance metric (as promised), but with encouragement to “break the rules.”  There is no discussion of which rules should be broken or which rules should be followed, which can be quite dangerous if he is “selling” his ideas to the uneducated and/or inexperienced entrepreneur.  Not surprisingly, he provides no benchmark level for this metric either.  His “ratio” is nothing more than encouragement to innovate by questioning the status quo and generating ideas on process improvement.  As with his other three non-financial metrics, this “new” advice on innovation has been in the marketplace for quite a while.  Maybe he should check out “Every Manager Can Be an Innovator” for some ideas on how to extend innovation throughout his Company’s business model.

Hopefully, you now share my grumpiness about this “fluffy” article, and are now asking how and why this CFO ever was allowed to publish this piece in what many consider to be a well respected, and reputable media outlet.  Well, you don’t have to search far for the answer…simply google “MedCloth and Deloitte,” and the answer will be clear.  You will find that MedCloth’s reporting manager came from Deloitte, as did one of the Company’s senior accountants.  Additionally, a Deloitte partner Tim de Kay acknowledges providing client services to ModCloth on his LinkedIn page.  So what,  you ask?  Well, Deloitte pays the WSJ to publish such articles. 

So, given the superficial nature of this ModCloth CFO article, this grumpy old accountant must conclude that it was nothing more than a shameful exercise in hyping a future Deloitte technology IPO client.  Doesn’t this call into question pretty much everything published in the WSJ’s CFO Journal?  Now I have to view all WSJ articles with greater skepticism (if that’s possible) to decide if they are really news, or just marketing promotions (as apparently this one was).  And, if it wasn’t bad enough that Deloitte has recently damaged the credibility of audits, now the firm is contributing to pseudo-journalism thus further hurting society.  There has to be a New Year’s resolution in here somewhere, right?

This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.

AuthorAnthony Catanach

For those of you that may have thought that my grumpiness may have been tempered a bit by the advent of the holiday season…Bah Humbug!  There is just so much accounting and financial reporting nonsense out there this quarter, that I have been simply overwhelmed by stuffing stockings with lumps of coal for my favorite global accounting firm (GAF) partners, and the humbug large bank clients they serve.

Let’s begin with Jonathan Weil’s recent discussion of Morgan Stanley’s “immaterial” $9.2 billion correction of an operating cash flow (OCF) classification error.  The problem?  Morgan Stanley (MS) accountants didn’t formally restate the Company’s financial reports for the error as required, instead opting for the sleazier “stealth restatement” route on the basis of immateriality.  Where were the auditors?  Well, the auditors actually appear to have discovered this error…my heart be still.  But MS has been “audited” by Deloitte (of recent PCAOB fame) since 1997 according to Audit Analytics.  Why should I be surprised that a GAF auditor actually found something, then looked the other way?  

AuthorAnthony Catanach

Several years ago, the Grumpies were pretty hard on the agencies tasked with enforcing audit quality and ethical accounting behavior in the United States (see Paper Tigers: The U.S. Accounting Oversight Regime).  But my how times have changed…the “Paper Tiger” has become “Tony the Tiger,” and that is just grrrrreat!  What am I talking about?  Well, it has been a really bad month for the global accounting firms (GAFS).  

AuthorAnthony Catanach

When we think about the worst U.S. accounting scandals ever, those new to the profession usually cite the Lehman collapse or Madoff scam of 2008,  or maybe even the Enron tragedy in 2001 which has become symbolic for bad accounting and auditing.  And those of us with gray (or no hair) might recall the ZZZZ Best, Crazy Eddie, or Equity Funding debacles.  However, many of us may have missed what may be the largest and longest running accounting swindle ever, one that finds accountants scamming accountants.

AuthorAnthony Catanach

With yields on fixed income securities at or near historical lows, today’s retirees and those planning for retirement are facing major challenges.  Not surprisingly, many individual investors as well as pension funds increasingly are turning to high-yield bonds and bond funds to meet their income requirements. So what’s the problem?  An increasing number of bond funds, pension managers, and other institutional investors are loading up their portfolios with an untested and unproven product about whose long-term performance we know very little:  the event-linked security or catastrophe bond (CAT bond).

AuthorAnthony Catanach
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I love Twitter!  Why you ask?  It allows me to easily discover and distribute content…that’s why!  But as Twitter continues its march to a November 15th offering date, there’s a storm brewing that just might end this love affair.  The Company’s recent filing raises a whole new series of questions about its strategy, business model, AND accounting that probably won’t get answered before its initial public offering (IPO).  There just isn’t enough time left for capital market regulators to force answers (thanks to the JOBS Act), nor is management likely motivated toward transparency given the nature of the issues. 

AuthorAnthony Catanach