Truth in Reporting --Dickeson

One thing that has puzzled me for many years is how printing companies can stay alive with the kind of operating income they report to the Printing Industries of America (PIA). These reports are the basis for the Ratio Studies that PIA publishes annually. Surely the reports of 600 to 900 companies, as a cross-section of our industry, must be true. Or...as true as can be expected with the general ledger financial reporting system we have in place.

Am I suggesting that there's something wrong with the general ledger system we use? Do I join with Trevor Harris, chief accounting analyst at Morgan Stanley, in saying "the financial reporting system is completely broken?" Perhaps. Take a hard look at the last six years of the PIA Ratio Studies and tell me what you think.

The Upper Quartile are the results of the upper one-fourth of the operating income-reporting printers. The Lower Three Quartiles are firms in the lower three-fourths. PIA usually reports only "All Firms" and the "Upper Quartile" of firms. Obviously, reporting the "Lower Three Quartiles," as I've done, would be embarrassing to the industry and to the trade association. Broken or not, they're reporting with measurements we've given them.

How did we get into this condition. . .or are we? It all depends on the assumptions you make and how you apply them. Goodness knows you've got to make a lot of assumptions.

First, there's the difficulty of measuring when there's more than one business in the firm. The report is premised on "operating" income of a printer. Suppose you have a profitable publishing firm, as well. How do you allocate many of the general, administrative and sales expenses? How many of those expenses were "operational" to printing alone between the two operations? You make assumptions, some of which may be true, but well wide of the actual results.

When is a Sale a Sale?

Next, we "accrue" sales. That is we call a transaction a "sale" before we collect the cash for the sale and call it a receivable. Then we make an assumption that "X" proportion of those receivables will not be collectible. That's then an expense we call a "reserve." Next, we may write some of the accounts "off" and charge that reserve. I'm not kidding!

That's all according to GAAP (Generally Acceptable Accounting Principles). If we're working on a long-term contract that runs across the year-end, we may make an assumption concerning the proportion of the completed transaction, take that as a sale and offset some expense. How much? Tell me. More printing companies than we dare acknowledge have eaten crow on this set of GAAP assumptions.

But maybe we're financing our receivables for some cash-in-pocket and we have that nasty "trip-wire" provision in the arrangement. Suddenly that account is 61 days past due and then the receivable is reversed and back among expenses! Or is it sales again? And what kind of a sale is that?

Inventories are another set of assumptions as to age and value of stock on hand. Do we write them off—or just partly down? What assumption do we expense for shrinkage or aging? Shall we charge the reserve or expense for this Halloween orange fiber-gloss paper that we'll never use? And we've got to replace a valuable stock at market that's now a lot higher than we can expense.

There's that bundle of fixed assets to be depreciated on some set of variable assumptions. If you're not leasing them and maybe even if you are—depending. Is that an expense? Or your plant is on land that you bought five years ago and is now worth twice what you paid for it. No assumptions apply here. No depreciation or appreciation is allowed.

Stock Options

Is the company publicly traded or not? If it's not, there's a tendency to increase expenses and pay less federal and state income taxes. If it's a publicly traded concern, then the tendency may be the opposite in order to make it look more profitable to investors. Differing assumptions may apply.

A very large proportion of our companies are privately owned. In nearly every private company that I know, there are certain problems involving relatives or other personal affinities. They're not small problems! They may also be present in publicly traded businesses. The problem of compensation and effectiveness always rears its ugly head. Even more difficulty is presented when relatives or other "untouchables" disagree on matters of policy or execution. How do we solve such problems? How many of the three-quarters of lower operating income firms in the table have solved such problems by accepting greater expense than warranted? Are you discomfited by my openly talking about it?

There's a real problem with GAAP and the host of assumptions involved with the General Ledger System of Accounting. It's so deeply entrenched in our fabric of tax laws and market valuation that there's little we can ever do about it—except tinker and fiddle. Probably we should just stop placing so much reliance on benchmarking and comparison with other firms using GAAP assumptions.

Personally, I'm quite suspicious of all the magazines that tout the hundred best colleges, hospitals, investments, businesses, etc. Let's get down to cases and make our decisions based on the real conditions that exist and trim away all the damned fool assumptions!

About the Author

Roger Dickeson is a printing consultant located in Pasadena, CA. He can be reached at rogervd@sbcglobal.net. A PDF copy of his recent book Monday Morning Manager is available without charge by e-mail request.