Attended a taster seminar by Mr Bob Ryan of Manchester Business School.
Interestingly he is rumoured to be the examiner for ACCA’s new financial management paper. After listening to him for 2 hours, I wish “All the Best” to those taking that paper :)…
Back to the topic proper.
What is the issue?
When companies are required to show aggressive numbers, creative accounting (hei! actually some are not so creative after all) becomes the order of the day. Companies like Enron, ACCS and Informatics are at various stages of proving their respective revenue recognition being true.
Is there a magic panacea to detect this problem before it explodes and takes the savings of thousands of good hardworking people and places thousands of people out of work?
The ultimate test of a true revenue is whether that revenue is convertible to “CASH”.
The question an investor, a good CEO, a good CFO should asked is whether the Operating Cash Flow (OCF) commensurates with the rapidly growing Operating Profit (OP). If OP had grown by 300% while OCF grew by a meagre 2%, one should ask where had the OP gone to?
The panacea as proposed by Mr Bob Ryan required us to calculate the COP, Cash to Operating Profit ratio.
COP = EBITDA / OCF
The steady state would be COP = 1 where a $1 of EBITDA would translate to $1 of OCF.
Mr Bob Ryan said the ratio would have detected a severe dislocation in ENRON given its COP of 19!!!!!!
Tired and sleepy.. pardon me for any typo and factual disjointment..
Good night and take care.