Financial illiteracy - a dangerous media trend

Profile picture for user gonzodaddy By Den Howlett August 16, 2016
Summary:
The summer's slack period has seen some slack assessment of financial events. It is a dangerous trend that needs addressing.

bean counter 1
Media often has a hard time making sense of financial statements. That's hardly surprising. Threading your way through reported accounts is never straight forward.

But I am minded that I was once told by a colleague whom I otherwise respect greatly that you can learn the basics of accounting in a weekend. I must have wasted the three years it took me to learn about accounting as part of my professional qualification.

What worries me is that I am seeing too many instances where the writers are suffering from basic financial illiteracy or are cherry picking snippets of financial information to create a headline, when the reality is far from that implied in those same headlines.

This example, created by Statista and then regurgitated by Business Insider is particularly worrying. Check the chart:

Google Russia fine

You might look at that and go - WOW - nothing more than a mild slap on the wrist. And you'd be right. Except that the analysis and chart upon which this is based is wrong. This is what Business Insider said:

As this chart from Statista shows, though, that’s a drop in the bucket for the Mountain View company. Given that Google’s parent company Alphabet earned $21.5 billion in revenue last quarter, it’d only take 41 minutes for Google to earn that fine back.

(My emphasis added.)

In order for Google to pay the fine, which is a cost to them, they have to get it from operational income and cash flow. It's not enough to call upon revenue since basic accounting principles demands that revenue is matched against costs in order to arrive at the bit that's left over aka operational profit. In this case, a fine is a cost.

According to Alphabet/Google's 10-Q for FY 2016, the company throws off the following numbers:

Google Q2 FY2016 numbers

As you can see, Statista has concentrated solely upon the revenue number. Depending upon which number matters more to you, Statista should have said that 'Google has to generate additional revenue in order to meet the cost at its current profit margin and then fund that out of cash flow.'

(My emphasis added)

In this case, the differences are small in relation to the broader Google picture and that's certainly important. But the fact remains the way Business Insider has presented the figures gives rise to a false sense of what Google needs to do in order to maintain the status quo as it relates to its numbers. How different for example might it be if Alphabet/Google was slapped with a $67 million or $675 million fine?

For reference, here is a chart I created from the above spreadsheet calculations which shows the per minute numbers expressed in revenue, operating income and cash flow terms

Aplhabet minutes

As you can see, Statista and Business Insider chose the smallest number. I wonder why?

Moving on. Business Standard offered us this screamer of a headline: Brexit tremor hits Infosys as news, declaring in the text that:

Infosys chief executive officer (CEO) and managing director Vishal Sikka’s plans to stabilise business and focus on higher growth at the Bengaluru-based company faced a Brexit impact after the Royal Bank of Scotland (RBS) shelved plans to set up a separate bank in the United Kingdom (UK), for which Infosys was a key technology partner. Infosys could lose as much as $50 million as it plans to shift 3,000 people from this project to other clients.

This story is a horrible conflation of an entirely different story which the FT reported upon. It said:

Royal Bank of Scotland has cancelled a $300m contract with Indian technology company Infosys after earlier this month dropping plans to launch Williams & Glyn as a standalone bank.

 The state-backed lender, which is 73 per cent owned by the UK government, has terminated a deal with Infosys, prompting the software services company to “ramp down” about 3,000 roles.

Infosys has until now been a technology partner for RBS, helping to create and test the standalone systems that would underpin Williams & Glyn as a separate “challenger” bank. The contract was worth about $300m in revenues for Infosys, according to analyst estimates.

Was this anything to do with Brexit? During the last earnings call, there were 18 references to Brexit. There was also reference to a previously announced issue in the banking sector. Addressing those points specifically, Vishal Sikka, CEO said during prepared remarks on the latest quarterly earnings call:

It is still too early for our clients or for us to specifically determine the impact of Brexit other than possibly the cautiousness that comes with the short-term uncertainty.

(My emphasis)

This was something Sikka repeated several times on the call. To a further question on the topic of financial services slowdown, Sikka said:

So, Rod, this was unrelated to Brexit. The one example, I think Mohit gave earlier, in the earlier call was pertaining to slight slowdown that we saw, which was not actually significant related to Brexit. However, the slowdown in Europe that we saw is related to the two things that we talked about earlier, the slowdown in the discretionary spending relating to consulting services and package system implementations, as well as one of the large deals that we had won couple of quarters ago that we had expected to ramp up at a faster rate than it did over the course of the quarter. Both examples were in Europe. So that is the reason that we saw the slowdown in Europe. It was not related to Brexit.

(My emphasis added)

Sikka's answer provides a very different picture to that painted by Business Standard, which chose to ignore remarks from less than a month ago. To make matters worse, The Business Standard article overlooked several important factors.

  1. A $50 million impact on revenue in the current year is a rounding error for a company that generates $8.5 billion revenue per annum. It is 0.59% to be precise. The earnings impact is minuscule since Infosys has plenty of flexibility in its operating model and is endeavoring to automate many mundane tasks, which in turn should mean improved operational efficiency. The balance of impact in 2017, where estimates suggest negative $150-170 million, is more serious but again, a small number in relation to the whole and with plenty of time to make up the shortfall.
  2. Infosys has already talked about 'down ramping' 3,000 people impacted by the RBS cancellation. Given the flexibility in Infosys model, the overall performance impact will likely be small, assuming no accretive business, based upon the current model and a far cry from Brexopolypse implied by Business Standard.
  3. We have been following Brexit very closely since the result was announced. So far, and apart from a few isolated cases, we have not seen any discernible change in the contracting environment such that would lead us to believe there is a trend in play directly related to Brexit. Vendors generally are quietly cautious as you'd expect, but we have yet to see any seismic shifts. We do however see some in the banking world blaming Brexit in circumstances that make no sense to us.

To its credit, Business Standard did point to others in the services arena who were impacted, especially Cognizant, which saw a $40 million headwind based upon currency fluctuations in its latest reporting quarter. But while many may attribute the currency issue as one directly connected to Brexit, every US dollar denominated vendor in every segment of industry will be reporting similar issues. There is nothing unique going on here.

In short, Business Standard has cherry picked, made assumptions that conflate one set of reported facts with unsupported assumptions about revenue generation and failed to pick apart the story elements that are relevant in this case. It is both lazy and misleading.

My take

It is bad enough that vendors play fast and loose with non-GAAP earnings as a way of fooling the market that they are performing better than they really are. Others will disagree but then you have to look at their agendas with knowledge of what the reporting rules are there for. Nine times out of ten you're looking at a need to pump or support a stock price.

It's high time that media which chooses to report on financial events makes certain that it understands what it is talking about rather than peddle the results of financial illiteracy and cherry picking to suit an agenda. The problem is that these kinds of weird or dumb ass reports have a habit of becoming part of due diligence packs and who knows what sorts of decision are taken as a result or what distracting queries are raised during an evaluation?

And yes - as an ex-bean counter I tend to be a bit pedantic about these things.