Overly Optimistic Financial Statements (802 words)

Third of 5 of the Most Common Mistakes to Avoid When Growing Your Business

One of the hardest decisions every leader has to make is allocating and managing scarce limited resources normally through some version of a capital expenditures process (CAPEX). Which is why this article will focus on how overly optimistic financial statements can impact your crucial prioritization decisions.

As the first step in that thought process, where do you need to re-evaluate the accuracy and usefulness of current financial statement balance sheets, income statements and existing processes? What really complicates your evaluation and increases the likelihood of a major mistake in growing your business is that generally accepted accounting principles (GAAP), tax regulations and a plethora of official sounding principles often say the financial statements are fairly stated. Translate that as close enough, reasonable or at least acceptable. Yet, in a heartbeat some of you would sell one or more assets for a fraction of balance sheet value, if hitting this month’s numbers would allow.

Once you open your planning to the fact that numbers acceptable in the accounting world may not fully reflect near term reality in the economic world in terms of making optimal business decisions, you will see some interesting options. Start with asking yourself to answer true or false on this statement. My business occasionally capitalizes expenses that create assets which now may have questionable recorded value.

Whether helping clients or speaking to groups in an off-the-record setting, the vast majority of leaders acknowledge this may be happening. It happens to us all, often more than once. Companies of all sizes have legitimately capitalized items in the past that should be consistently re-evaluated and questioned. Some may ask, does it really matter if the CPA firm, banker and the IRS are happy enough?

For you to go deeper on this question, consider the impact when using marginally useful financial information you invest scarce resources on proposals which go the wrong direction for the company.

On the upside, if you invest capital in cutting edge resources synonymous with practical innovation your organization can grow and profit in a monumental way.
On the downside, no company has the luxury of unlimited best people, money and time. With outdated or inaccurate information, it is easier to squander those limited resources.

The High Cost of Making Mistakes with Outdated or Inaccurate Financial Information.

People always like a classical or current story to illustrate sometimes esoteric business or accounting concepts.

Even large companies with access to award-winning systems still make monumental mistakes when they misinterpret the market, or ignore sanity checks. A classic example is where Cisco, a worldwide leader in Information Technology misread the market. Cisco had world class information systems and processes for financial reporting and operational controls, when it wrote off $3 billion of inventory in 2001. Cisco admitted they misread the market downturn. In a series of widely discussed articles the focal point was “how could a write-off of such magnitude happen to a company with such incredibly sophisticated systems?”

At least, Cisco was honest about making an embarrassing mistake. It’s incredible what the enormous cost can be for organizations that don’t evaluate their decisions thoroughly, and temper that with common sense. It is always hard to keep your head when others are losing theirs.

Closer to home, think of the last time you saw, heard or were part of a situation where a new CEO came in with the luxury to clear the decks and write off everything except the kitchen sink. (I helped in several such reviews.) When I tell people that going forward their incentive plan will be based on a return on equity invested in their unit, and there is a limited window to clean up a “few things, what do you think happens?

If you have reserves, allowances or estimates for loss, why not take a more critical look at them now and at least once a year going forward to decrease risk?

When bad things happen to good companies, because they didn’t correct or re-evaluate previous decisions, the end result can tarnish a company’s image instantly.
Constantly re-evaluating decisions and capital expenditures from all angles avoids scapegoats and maintains a flourishing business.

Building on these discussions, where should your business look to avoid letting small economic inaccuracies become so large that a new CEO will come in and sweep out you or some colleagues as part of their clear the decks process? If politically necessary, why not get an outsider to wear the black hat?

How long will it take for one of these actions to help your business make more bottom line profits by better managing limited resources available to create sustainable growth and profitability with more accurate financial information?

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Known as the Fiscal Doctor, Gary W. Patterson has helped 2 INC 500 companies and over 200 companies in manufacturing, technology, service, construction and distribution in companies from start-ups to Inc. 500 to Fortune 500. Gary Patterson helps you grow top line revenues, keep more of the bottom line and make life more fun. Author of Find Your Blind Spot – Before It Finds You, and Million Dollar Blind Spots. Contact Gary when you need a speaker or consultant on strategic profitable growth while removing risk at www.FiscalDoctor.com or 678-319-4739.

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Overly Optimistic Financial Statements (802 words)