12 ways a company can inflate profits and valuations


Nobody really knows what has happened at Satyam. No one will ever know unless Mr. Raju writes an autobiography. Ever since the whole thing broke out there are numerous reports about what has happened and what will happen at Satyam.

Some even went on to capitalize on this madness by offering a inside-out report for $499. That is not a typo. The price was really four hundred and ninety nine dollars only. Like all seasonal things one more study came out about a brand new observation that 1 in 5 of the BSE 500 companies have accounting discrepancies.

Few people were worried about the operating margin of Satyam and tried to extrapolate it to the whole IT industry. Many people mentioned about the lack of transparency and the failure of corporate governance. What were the independent directors doing? What were the auditors doing? Why do we need SEBI anyway? And so it went.

But nothing useful was written so far. I should point to Gurucharan Das’s column about how we should see the problem. That should give a different angle to the story.

I read today about 12 ways a company can inflate its profits in Mint which was done with the collaboration of Crisil. The 12 ways make up for an interesting read and gives you some brand new information. If you are planning to become a CEO or CFO these 12 ways are a must read.

Don’t think that these are the only ways to inflate profits. This will also be useful for investors who will not go by the irrational exuberance around them and actually go through the annual reports of a company.

12 ways a company can inflate profits :

  1. Write-off expenses from reserves
  2. Show previous year’s expenses as this years income
  3. Revalue assets to write off losses/expenses
  4. Revalue assets to write off transfer values
  5. Show loan waiver as income
  6. Transfer loans to associates
  7. Transfer fixed assets to current assets
  8. Continue with dead projects.
  9. Inventory valuation
  10. Inflate sales
  11. Sale/Lease back of assets
  12. Change depreciation policies.

From the 12 ways above, #6&7 are the things which Raju tried when he proposed to buy Maytas properties. There will be no cash exchanged but the books will be clean. #10 is what has happened to show inflated profits over the period of time. This of course is based on the first version of Raju’s letter. But, the case has shifted focus since then because of new revelations that the money is siphoned off.

There are 2 other things that were used to inflate profits from the Satyam episode:

  1. Overstate the debtors position
  2. Show interest accrued when there wasn’t any.

The next list should be 12 ways to siphon off funds. Let me start with the first one. You can try filling in the rest.

  1. Inflate employee count and divert those funds to one of your 200 companies.

PS : If a company has more than one business like a conglomerate it is very easy to do all kinds of financial gymnastics. There are very few companies like these.

  1. Sriram Vadlamani says

    @Gargi : I don’t think it was necessary as the 12 ways or any number of ways came to public eye only after the fall of Raju.

  2. Gargi Dixit says

    You forgot to tell that when the bubble of inflation caused by any of these 12 methods bursts, a person falls in the pit of defeat and worthlessness from the heights of sky just like Raju fell.

    A Honest man knows that he cannot consume more than what he produced!

    Ohh but yes, Honesty can be the scale of success only in a free market not in a controlled market where the government is always ready to either facilitate frauds or to hide them up or to mitigate them in useless and prolonger investigations inquiry committee and then ultimately bail outs with a let-free passage for the corrupt.
    bankrupt Satyam, pay off all bank charges of India and US and others who have been defaulted and let the new buyers of Satyam to handle the company and workforce with a new start, let it be free market solution!

  3. Sriram Vadlamani says

    @Gopinath & Vol : Audits and transparency can go only so far. That is what Gurucharan Das link given above says. I totally agree with it. It is not colossal failure.

    The post is to educate the investors of the ways it can be done and what to look for if at all someone looks at the annual reports before investing.

  4. Vol says

    It is sad there is not more ways to get transparency from companies, so they can not be able to pull this kind of stuff off in the future!

  5. Gopinath Mavinkurve says

    Hey, guys – you seem to be doing what Raju plans to do shortly. To set up a university to teach the world how it can all be done! Meanwhile PWC says only random audits are conducted. Well, which figure in the financials has not been falsified? And how does PWC manage to pick these from the several ones that have been fudged? Good post to educate the lay investor (assuming that is what the post does). The pros may not need these handouts, would they? Purchase management professionals always talk about Caveat Emptor – Buyer, beware. Seems to be more apt for buyers of equity too!

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