Category: Corporate Finance


Madrassas or schools of Islamic theological learning have been in existence for a very long time. These schools impart education relating to purely religious disciplines and traditionally,  the graduates of these schools become prayer leaders as the education imparted in these schools have no relevance to any other occupation. Normally, not all the mosques had Madrassa attached to them. These schools were run on the donations and the administrators, teachers and others attached to these Madrassas had modest means of living. So had the boarders.

Then came the Afghan war (1979-88) when Madrassas in Pakistan were used as Jihad nurseries. Many of the Mujahideen were educated in these Madrassas which were basically Saudi-financed and were used not only for Jihad training but also to teach and spread Wahhabism, a particularly austere and rigid form of Islam which is rooted in Saudi Arabia. This is in spite of the fact that a large majority of Pakistani Muslims do not subscribe to this violent version and are followers of mystic Islam. With Saudi money, the Madrassa became an industry with mushroom growth. These Madrassas may in fact, be richer than expensive and elite school systems.

Around the world, Saudi wealth and charities contributed to an explosive growth of Madrassas during the Afghan jihad against the Soviets. During that war (1979-1989), a new kind of Madrassa emerged in the Pakistan-Afghanistan region — not so much concerned about scholarship as making war on infidels. The enemy then was the Soviet Union, today it’s America. The administrators of these Madrassas now play in a pool of wealth with SUVs and army of personal bodyguards at their service. It shows that Jihad and Madrassa are not for religious reasons anymore, it is a profitable occupation. With free flow of oil money, number of Madrassa all around Pakistan has multiplied in geometrical proportion in recent years. For those interested in quick bucks, Madrassa provides excellent opportunities.

There is no space for the graduates from these schools as there are not as many mosques. The consequence is opening of new mosques and Madrassas and multiplying the number of graduates who are next to illiterates as far as the “worldly” occupations are concerned. The other consequence of violent preaching of Saudi Islam is very obvious and need no explanation. But the fact remains that Madrassa is a business case with huge profits and no business risks. These Madrassas have defeated super powers on economic grounds; for them war has become a losing proposition both in military in economic terms. For Madrassas and Jihad, it is a business case, profits and excellent returns on someone else’s investment. 72 virgins and a mansion in paradise is on top of that. For details please go to: http://www.pbs.org/

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Do you have any idea how management of another State Enterprise, a national flag carrier has mis-managed Pakistan International Airlines Corporation. With its aircrafts packed to capacity and with its misplaced economy in the areas of passenger service, it is still running into losses to the tune of billions. Like Pakistan Steel, it is on the lifeline provided by the Government in the form of bail-out package every now and then. These packages alone are going to sink the national ship of economy. For how long will the poor masses pay for inefficiencies and corruption in the high places in Public Sector entities?

And mind you, PIA has all the elements of a vibrant organization. It has 40 aircrafts flying to 59 destinations. Its slogan proudly says, come fly with us. But it seems that the only thing flying these days is cash out of PIA coffers. It is the same organization which was in dire straits in the 90s but recovered in 2000 onwards.  It was earning profit till 2004 (Rs. 2.31 billion) where after it started losing altitude and eventually was nose diving. At the end of 2008, it had a loss of Rs. 36 billion. Major reason for its downfall is its number of employees per aircraft which is highest in the world. Since it has a very attractive compensation package, every political party tried to stuff it with its workers or the ministers and MPs sold PIA jobs during their regime. Steel Mills, Railways and PIA are going to destroy Pakistan if their management is not corrected and they continue to breathe under oxygen tent of bailout packages.

Those dealing with accounting profession in the South Asian region are already familiar with the discipline of creative accounting. In this discipline, of course not approved by professional bodies or scrupulous professionals, accounts are prepared in the fashion of reverse engineering where end-product i.e. Financial Statements are prepared first and ledgers, trial balance etc are doctored later, of course in keeping with the requirements of the Financial Statements. With tighter controls by the professional bodies like ICAP a Pakistani equivalent ICAEW, and regulators like SECP, the practice is checked but with the mindset of creative accounting, its existence here and there in one form or the other can not be ruled out.

This seems to be a global phenomenon as financial statement manipulation is an ongoing problem in corporate America. Although the Securities and Exchange Commission (SEC) has taken many steps to mitigate this type of corporate malfeasance, the structure of management incentives, the enormous latitude afforded by the Generally Accepted Accounting Principles (GAAP) and the ever-present conflict of interest between the independent auditor and the corporate client continues to provide the perfect environment for such activity. Due to these factors, investors who purchase individual stocks or bonds must be aware of the issues, warning signs and the tools that are at their disposal in order to mitigate the adverse implications of these problems.
In an article recently published by Investopedia, there are three primary reasons why management manipulates financial statements. First, in many cases the compensation of corporate executives is directly tied to the financial performance of the company. As a result, management has a direct incentive to paint a rosy picture of the company’s financial condition in order to meet established performance expectations and bolster their personal compensation. Second, it is relatively easy to manipulate corporate financial statements because the Financial Accounting Standards Board (FASB), which sets the GAAP standards, provides a significant amount of latitude in the accounting provisions that are available to be used by corporate management. For better or worse, these GAAP standards afford a significant amount of flexibility, making it very easy for corporate management to paint a favorable picture of the financial condition of the company.
Third, it is unlikely that financial manipulation will be detected by investors due to the relationship between the independent auditor and the corporate client. In the U.S., the Big Four accounting firms and a host of smaller regional accounting firms dominate the corporate auditing environment. While these entities are touted as independent auditors, the firms have a direct conflict of interest because they are compensated by the very companies that they audit. As a result, the auditors could be tempted to bend the accounting rules to portray the financial condition of the company in a manner that will keep their client happy. Moreover, auditors typically receive a significant amount of money from the companies that they audit. Therefore, there is implicit pressure to certify the financial statements of the company in order to retain their business.
How Financial Statements Are Manipulated
There are two general approaches to manipulating financial statements. The first approach is to inflate current period earnings on the income statement by artificially inflating revenue and gains, or by deflating current period expenses. This approach makes the financial condition of the company look better than it actually is in order to meet established expectations.

The second approach to financial statement manipulation requires the exact opposite tactic, which is to deflate current period earnings on the income statement by deflating revenue or by inflating current period expenses. The reason behind this approach may not be as obvious as in the previous example because it may seem counterintuitive to make the financial condition of a company look worse than it actually is. However, there are many reasons to engage in such activity, such as making a company look bad in order to dissuade potential acquirers, pulling all of the bad financial information surrounding the company into one period so that the company will look stronger going forward, pulling all of the bad financial information into the current period when the poor performance can be attributed to the current macroeconomic environment or to postpone good financial information to a future period when it is more likely to be recognized.
According to Dr. Howard Schilit, in his famous book “Financial Shenanigans” (2002), there are seven primary ways in which corporate management manipulates the financial statements of a company. Let’s look at these seven general categories of financial statement manipulation and the typical accounting processes that facilitate the manipulation.

  1. Recording Revenue Prematurely or of Questionable Quality
    • Recording revenue prior to completing all services
    • Recording revenue prior to product shipment
    • Recording revenue for products that are not required to be purchased
  2. Recording Fictitious Revenue
    • Recording revenue for sales that did not take place
    • Recording investment income as revenue
    • Recording proceeds received through a loan as revenue
  3. Increasing Income with One-Time Gains
    • Increasing profits by selling assets and recording the proceeds as revenue
    • Increasing profits by classifying investment income or gains as revenue
  4. Shifting Current Expenses to an Earlier or Later Period
    • Amortizing costs too slowly
    • Changing accounting standards to foster manipulation
    • Capitalizing normal operating costs in order to reduce expenses by moving them from the income statement to the balance sheet
    • Failing to write down or write off impaired assets
  5. Failing to Record or Improperly Reducing Liabilities
    • Failing to record expenses and liabilities when future services remain
    • Changing accounting assumptions to foster manipulation
  6. Shifting Current Revenue to a Later Period
    • Creating a rainy day reserve as a revenue source to bolster future performance
    • Holding back revenue
  7. Shifting Future Expenses to the Current Period as a Special Charge
    • Accelerating expenses into the current period
    • Changing accounting standards to foster manipulation, particularly through provisions for depreciation, amortization and depletion

Investors should understand that there are a host of techniques that are at management’s disposal. However, what investors also need to understand is that while most of these techniques pertain to the manipulation of the income statement, there are also many techniques available to manipulate the balance sheet, as well as the statement of cash flows. Moreover, even the semantics of the management discussion and analysis section of the financials can be manipulated by softening the action language used by corporate executives from “will” to “might,” “probably” to “possibly,” and “therefore” to “maybe.” Taken collectively, investors should understand these issues and nuances and remain on guard when assessing a company’s financial condition. (Courtesy: Investopedia)

According to Wikipedia, the first ever shares were issued by Dutch East India Company to be traded in Amsterdam Stock Exchange in the year 1602. It became the first company to issue stocks and bonds. London Stock Exchange started trading in stocks and bonds much later, in fact as late as 1688.

The Dutch have another role relating to Stock Exchange.

New York City of today was 17th century New Amsterdam, major city of the state of New Netherlands. It was a Dutch colony always at war with New England, the state of Connecticut, who would invade the city from the North. In order to protect New Amsterdam from enemy attacks, a huge wall was built which unfortunately, could not save the city. It was attacked and taken by the English who dismantled the wall. Instead, they built a street at the site of the wall. We all know that street by the name of Wall Street. It is the financial nerve center of the whole world.

The Stock Exchanges raise capital for businesses, mobilize savings for investment, facilitate corporate growth and create investment opportunities for small investors. At the stock exchange, share prices rise and fall depending, largely, on market forces. Share prices tend to rise or remain stable when companies and the economy in general show signs of stability and growth. An economic recession, depression, or financial crisis could eventually lead to a stock market crash. Therefore the movement of share prices and in general of the stock indexes can be an indicator of the general trend in the economy. Karachi stock Exchange is one of major bourses of the world.

Dividend

Companies are owned by common shareholders who are entitled to receive profit in return for their investment in the equity. It is for them to decide whether they want to: (a) distribute the entire profit among themselves which is called Dividend, (b) retain the profit for further expansion of Company’s operations, or (c) split profit for both paying out as dividend and retention for further expansion. In each case, the decision is initially taken by the Board of Directors and finally approved by all the shareholders through annual general meeting (AGM). Part of profit retained and paid out is calculated on the basis of retention ratio and pay-out ratio. The decision to pay out dividend is taken when the accounts have been audited, amount of profit firmed up and finally approved by AGM.

Sometimes, it so happens that Companies want to announce dividend in anticipation of finalization of accounts and approval of AGM. In that case, they pay out a portion of anticipated profit which is called Interim Dividend.

Please feel free to contribute and also ask questions.

Very simple. Isn’t it?

Working capital has two components, current assets and current liabilities. As a matter of fact, it is sum-total of current assets less current liabilities. It will work for you, or for your business, if you keep it under efficient management. It will work wonders if the current liabilities are not allowed to overtake current assets. Then it will be the life blood of your business, it will keep your short-term creditors happy and away from you and meet all day-to-day expenses of the business. However, if you allow the current liabilities exceed current assets, your business will come to a grinding halt and you will be locked in legal battles with your creditors. The only business you will be running will be asset-disposal.

Word of wisdom: Learn ratio analysis and keep a watch on current assets and current liabilities. Don’t over-stretch your credit sales. Don’t keep your inventory for too long unless you have bought it for free. Timely collection of debts, delaying payments and effective internal control system are some of the soldiers that you can deploy for safeguarding your business territory. And the good thing is that you don’t have to be a professional accountant to do that.

Some people use working capital to mean cash. It is not the whole truth unless all your current assets other than cash were financed through current liabilities.

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