😕😕12 Points To Quickly Check the Quality of Accounts

R Balakrishnan
11 June 2018 Source: Moneylife.in



Of late, several auditors have refused to sign accounts or companies have been unable to declare results on time. For the first time in India, the audit profession is facing the heat of the regulators. This has long been overdue. Which brings us to the debate about the extent to which we can rely on the declared numbers and whether there is a way to figure out what is good and what is bad.

Investment decisions are based on ‘audited’ accounts provided by companies. The auditor is effectively engaged by the promoter because he dominates the voting. Every promoter wants a ‘reasonable’ auditor, while every investor wants a ‘policeman’ auditor. And auditors were never legally culpable. The Securities and Exchange Board of India (SEBI) has changed that. Kudos to them!

Many companies are switching auditors. There may be many publicly disclosed reasons, but I suspect the truth is that the existing auditors are not happy with the numbers that the promoters want to peddle. And there are generally safe-sounding reasons for change.

As an analyst, my tasks are made harder by changing regulations that have reduced financial disclosures in annual reports, making it more difficult to spot frauds. Annual reports, today, are short on facts and long on management hyperbole that covers 90% of the annual report. There are many ‘schedules’ to the accounts that have been eliminated and attaching accounts of subsidiaries is not mandatory. The Institute of Chartered Accountants of India and the regulators have played along, to reduce the disclosures in the annual reports.

Auditors can only be as good as the promoter wants them to be. We cannot expect them to go beyond some checks. For instance, if I were to buy some customised equipment for my company, there is no basis for comparison. None of the capital expenditure is capable of being certified as 100% genuine by any one. I can simply take commissions or kickbacks. We can only check the overall cost on the basis of some ballpark estimates that go around. Similarly, the auditor has no way of ascertaining if the expenses were actually incurred. And an auditor can only do so much. So, what should an investor do? Personally, I like to go a bit deeper into the financials. Some of the boxes that I tick are:

1. It is good to start with reading the “notes to the accounts”. Often, there are auditors who put in some phrases that make you wonder about the truth. Or they may point to some issues that are not in conformity with the accounting practices. If there are red flags in this section itself, it may not be worth wasting further time on that company. When there are some adverse comments, there will also be a response from the management. It is also useful to see if there are ‘changes in accounting practices’ from one year to another. Generally, it indicates an attempt to over-/under-state profits.

2. Is the total debt declining? Or is there a visible reason for debt to increase? If a business is doing well, debt should keep reducing. Debt is often a killer and, unless the company is a bank or a non-banking finance company (NBFC) why should it rise? Rising debt hides problems in cash flow. Once in a way, when there is some expansion, there could be increase in borrowings.

3. What is the composition of fixed assets? Is there an excess of vehicles, furniture & fixtures? Is too much money at stake in land & buildings? What is the extent of ‘fictitious’ assets like goodwill, etc? I generally like to rewrite the fixed assets schedule in my own way: Land & Buildings, Plant & Machinery, Furniture & Fixtures, Vehicles, etc, for a four- to five-year period side by side and see if it makes logical sense. Is there too much of any one asset or too little of any other?

4. Are there too many associates where the company does not own 100%? Often, there are companies with ‘associates’ that are part-owned by family members and these associates can be just vehicles to siphon money out of the company.

5. Is the increase in gross working capital lower than the top-line growth? If the company has to extend more credit, or carry more inventory than proportionate to growth in sales, it is not a healthy state.

6. Is the RoE (return on equity) consistent? And does it more than cover the cost of borrowing?

7. Does the company pay tax? Is the tax rate logically correct? If tax paid is too low, I would rather pass up the opportunity.

8. Is the sales number something that is readily visible? Or is it something of an opinion, like in a contracting company? If a company sells cars or bikes, one can figure out the sales. However, when sales numbers are ‘estimates’, we get into slippery territory. I generally dislike contracting companies because of this. Sales numbers and cash numbers do not align themselves to analysis. I would rather be safe than sorry.

9. Are there many ‘associate’ companies that have a cash flow connection with the parent company? This is an open door and chances of manipulation remain high.

10. What is the trend in ‘Loans and Advances’? This is a black-hole and can hide a lot of money from the shareholders.

11. Transactions with related parties. It is useful to go through this part that is disclosed in the annual report. The more complex and lengthy it is, the more I tend to ignore the company.

12. Does the company have a lot of ‘cash & bank balances’ and, simultaneously, a lot of debt? Again, a red flag which could show that a lot of ‘window-dressing’ was done at the year-end date. Of course, one hopes that after the Satyam drama, auditors actually crosscheck with the banks on the balances as shown and signed off. I would be happy to see a separate statement in bold letters signed by the auditors as part of their audit report in the accounts.

In general, the numbers should tell the story themselves. It should not call for an IQ of 240 to decipher the numbers. And, for those of you who are fond of Excel sheets and numbers, look up “Benford’s Law”. In 1938, physicist Frank Benford made an extraordinary discovery about numbers. He found that in many lists of numbers drawn from real data, the leading digit is far more likely to be a 1 than a 9. In fact, the distribution of first digits follows a logarithmic law. So the first digit is likely to be 1 about 30% of time while the number 9 appears only 5% of the time. In a couple of cases, I have found this to be a good fit. Maybe auditors would do well to run this check on every annual report they sign off.

In this era of digital technology, it still takes three to six months for the audited accounts to be published. By the time an analyst can take it up, the next year is more than halfway through. Quarterly reports are just teasers aimed at pleasing investors. Thus, it is more useful to know about the promoters. This would limit us to companies with long track records and place speculative bets on new ones. Integrity and reputation are built over time.

Good companies will, over time, display improving financial health, throw out lot of cash, pay increasing dividends, pay income taxes, reduce their debt continuously and be in the top-3 or top-4 players in their industry. These companies would be ‘known’ and are too boring. Of course, there will be hardly a ‘joy of discovery’😜 in case of such stocks. 

software that can scrutinise 40 million pages an hour.

Hi, Saravanan :
India Today Big Brother's Online Watch

In the run-up to Union budget 2018, the information and broadcasting ministry, then headed by Smriti Irani, monitored in real time online conversations centred on the word ‘budget’. Kaushik Deka A team scrutinised social media platforms such as Twitter and Facebook and a number of blogs. 

Based on their analysis, finance minister Arun Jaitley acted to allay apprehensions about certain budgetary provisions. For instance, the analysis showed that Jaitley’s decision to make no changes in personal income tax slabs had led to a lot of resentment. 

On cue, the government decided to play up the decision to re-introduce standard deduction—set at Rs 40,000 in the budget—as a boost to the take-home pay of employees, even though its impact is marginal at best. 

Encouraged by this experiment and with less than a year left for the general elections, the I&B ministry has planned to set up a ‘Social Media Communication Hub’, contracting people across each of India’s 716 districts to keep their eyes peeled on trending topics and feedback on the Centre’s schemes. 

According to officials, those working on the project will be the ‘eyes and ears’ of the government and provide reports across both social and mainstream media, keeping as close an eye on newspapers, television and radio stations as on social media. 

The government approved the hiring of these personnel—one for each district presently, and 20 eventually—in February. They will compile at least six reports every day. According to sources in the ministry, the finance committee has sanctioned Rs 17 crore to set up the hubs. 

Broadcast Engineering Consultants India Ltd, a public sector undertaking under the I&B ministry, has floated a tender to supply software for the project. The document states that the platform will be expected to provide automated reports, tactical insights and comprehensive workflows to initiate engagement across digital channels, and should enable publishing features to help disseminate information. 

The new tool should be able to “listen” and respond to Facebook, Twitter, Google+, LinkedIn, YouTube, Instagram and “Google Play Store, email, news, blogs, complaint sites and forums”, says the document. It will “power a real-time New Media Command Room”. 

Cyber security experts, however, say the language of the tender is a violation of the IT Act, 2000. For instance, “listening to email” is not possible without the permission of the email account holder. “Even to monitor content on other platforms, intermediaries like Facebook or Google will have to permit monitoring, but they are not supposed to do that unless there is a specific court order,” says cyber security expert Subimal Bhattacharjee. 

He points to a 2009 notification by the Centre that allows the government to monitor online content only under specific circumstances and as a time-bound exercise requiring several approvals. The government’s intent is evident from the bid document, which requires that the social media analytical tool “should have a comprehensive analytics system to monitor and analyse various aspects of social media communication and [the] World Wide Web” and should be able to monitor emerging trends and “gauge the sentiments (of) netizens”. 

It should be a “guiding tool” for the ministry to understand the impact of social media campaigns run by the government. This is not a new idea. The existing social media analytics wing of the ministry currently scrutinises posts on social media platforms and generates reports for the PMO, the National Security Advisor’s Office, intelligence agencies and ministries such as home and defence. 

This wing uses software that can scrutinise 40 million pages an hour. 

(http://www.magzter.com/share/mag/5/279441/) (http://www.magzter.com/share/mag/5/278328/) (http://www.magzter.com/share/mag/5/277201/)

எதிர்காற்று ஒதுங்கி போய் பின்னால் இருந்து தள்ளுகிறதா

GDP growth shows headwinds of demonetisation and GST are becoming tailwinds

GAUTAM CHIKERMANE

The 7.7% growth in India’s gross domestic product (GDP) in the fourth quarter of financial year 2018 is more than a numerical statistic cobbled together by Prime Minister Narendra Modi’s policies, less than the record 10%-plus benchmark set by former Prime Minister Manmohan Singh government during 2010, and way below what India’s potential can be. 

Already the world’s fastest-growing large economy, this number strengthens India’s growth trajectory and gives us the luxury to think beyond, to aspire for a sustainable double-digit growth, which is not merely the announcement of the country’s coming of age but a necessity to carry millions of Indians on this growth train and offload them on a platform called Middle Class.

It is more than a statistic in the usual sense of the word because it captures within it the two strongest headwinds that India businesses have faced in the past two years, and arguably since 1991 — demonetisation and GST. 

Demonetisation that ruptured the informal economy, hurt cash sensitive sectors such as real estate, and reportedly led to job losses. And the biggest structural reform India has witnessed in the form of the introduction of the goods and services tax that began with sputters of administrative excesses but has now calmed down to a predictable and stable process.

The short-term pain notwithstanding, for the economy to negotiate these headwinds sector after sector, one enterprise at a time, shows the resilience of India’s business community in general and the grit of India’s entrepreneurs in particular. Give them a problem and they will find a way.

Headwinds of policy are not new to Indian business. From the intense bureaucracy, strong Inspector Raj and excessive controls of the 1960s and 1970s have already become the new normal. Entrepreneurs have found their way around these hurdles, while successive governments have flushed this policy sewage out. But what has not changed is an overall sense of suspicion against Indian businesses that exists till today. 

It is unlikely that the business community in any significant country would have faced such resistance to doing business, to building enterprises, to delivering jobs on the way and creating wealth as a sweet outcome than India. This is a national tragedy that the policy space ignores but desperately needs to rectify. We want to feed off the taxes of our enterprises but not respect the entrepreneurs behind them.

While there is no data to back it, part of this quarter’s GDP growth is due to the formalisation of the economy, brought about by the demonetisation-GST duo — the former by the entry of money into the formal banking sector through the doors of KYC (know your customer), the latter through a smart process of tax credits, both riding the fast train of digitalisation that India has embraced at a never-seen-before speed. 

Now that demonetisation has done what it needed to and waits for big data to segregate unaccounted-for money in the system form legitimate wealth, the GST system has more or less stabilised and businesses have adjusted to yet another new normal that has replaced 17 taxes with a single one, these headwinds will turn into tailwinds, tax stability will now translate into business stability and, ceteris paribus, push the economy towards a virtuous cycle of growth.

That said, 6.7% growth for the full year is only a start. It is unsatisfactory for an economy of India’s stage of development. Economically, this statistic it is an opportunity to consolidate the gains, visible and invisible, from policies that seem unrelated but in fact are part of a larger whole. Politically, it lags the growth rates delivered by Manmohan Singh’s government — this government needs to deliver more. 

But with the treasury filling up on both the indirect and direct taxes side, growth in taxes exceeds the growth in the economy and gives Modi a strong base with which to deliver social policies, crucial in his last nine months of his tenure as Prime Minister. The next three months should see the rollout of what may become this government’s flagship scheme — the National Health Protection Mission (NHPM) — a scheme as important to Modi as the MGNREGA was to Manmohan Singh.

In the journey of nations to prosperity, one statistic over one quarter is insignificant. The polarised politics of today doesn’t allow the government to indulge in a full-blown celebration of growth.

And, except in relative terms it doesn’t permit the Opposition to dismiss the number either. We need to see this number only as a start. We also need to get real: in a world that is increasingly transacting with ferocious tools of trade tariffs and economic sanctions, maintaining this growth in the short term will be a challenge. It would also be a time to get our house in order, remove the hurdles before our entrepreneurs and catalyse them towards attaining global scale. Unfortunately — and sadly so — we will have to wait for the results of Elections 2019 and see how the next government brings these changes.

Until then, expect GDP growth to rise at a higher rate over the next two quarters, tax revenues to gallop faster, leading to an increase in the tax-GDP ratio, which could cross 18%. But keep two risks in mind: global trade wars and rising oil prices.

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04 June 2018

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