PROFITS ARE WHAT businesses are supposed to be about. Shareholders start, build and continue to own businesses, in order to make profits. But all companies are not equal.
Profit margins differ among industries and to a lesser extent among companies in the same industry. If margins are too low, the company is reliant on debt to expand. If margins are too high, it attracts competition. Importantly, if the profits are real, the company can pay cash dividends.
While some shareholders may prefer that a company reinvest its earnings to create future wealth for shareholders, the sad reality, as noted by Benjamin Graham in The Intelligent Investor, is that few companies are able to reinvest such profits to earn the same rate of return as the existing business.
Besides assuring shareholders of a minimum return on their investment, a cash dividend also serves as useful, albeit partial, proof that the company’s reported earnings are real.
If the profits are real, the margins will also be similar to that of competitors – after all, with the same capital inputs, the same workforce, the same customers, and the same selling price, the profits must also be the same. Few companies are so unique that they have no competitors and can set any price they wish.
So what happens if the profits are fake?
Generally, if the profits are fake, it is because the reported profit margin is too high. This can be detected in a peer comparison with the company’s direct competitors, or similar businesses operating elsewhere in the world. Given today’s globalized economy, very few companies will leave a region alone if it is seen that a peer is making good profits there. Thus, excess profits are unlikely to persist, and over time profit margins go back to normal i.e. there is reversion to the mean.
Because profits and losses from the income statement are reflected in the balance sheet, fake profits will also show up on the balance sheet, often in the form of imaginary cash balances.
The problem here is that cash is a transparent and easily auditable item, which makes it a prime focus of auditors. Blatant fraudsters may of course collude with bank officials to produce fake statements to fool the auditors.
However, even if the auditors are fooled, as cash apparently builds up on the balance sheet, it becomes increasingly more difficult to fend off minority shareholder demands for cash dividends, or at least a repayment of outstanding debt.
One way to avoid having to show the cash to the auditors is to not collect it in the first place. This then causes the trade receivables account to swell. This topic was discussed 3 years ago in the June 2009 newsletter, so it will not be discussed further here.
If one does pretend to collect the cash, then the logical progression is to use up the fake cash on items which are harder to evaluate than cash. Popular choices include inventory, machinery, supplier prepayments, intangible assets and even other companies.
Inventory, specifically finished goods, can be a useful place to dump fake earnings, as finished goods comprise a mix of different costs such as raw materials, capital and labour. This creates more work for auditors, who are not interested in dissecting the business to figure out the true cost of finished goods.
In a retail business, the stock is also scattered across hundreds if not thousands of stores. So a retail company can dump fake earnings here and be fairly confident that the auditors are not going to do a thorough stock-take.
For example, Ports Design, a luxury apparel brand, has reported very high profit margins for the past 10 years. One would expect that Ports would then be sitting on a huge cash hoard. Instead, Ports has opted to plow much of its earnings back into inventory, to the extent that since the end of 2009, its inventory holdings have represented more than 18 months of sales.
But apparel, by its nature, goes in and out of fashion. Therefore, stock
4/25/2014 Total Tan is an independent company that designs innovative products to make the self fake tanning process as easy as possible. It is made up of a group of company of directors that between them have designed, financed and set up the total tan business model to effectively produce, market and sell self tanning applicator products. EXECUTIVE SUMMARY In the UK 41% of women use fake tanning products resulting in sales of £35m a year. This boom in the market has come from people's…
argue that counterfeits promote the trade for original items. So, let’s start by looking at some research from ABCNEWS. Chinese counterfeiting now costs foreign firms an estimated ['estimetid] $20 billion a year in lost profits. China is not only to make everything, but fakes just about every consumer product imaginable. And every day, tons of phony ['fəuni] goods are shipped out, mostly to the Middle East, Africa and South America. Why there are too many counterfeits come out of China? The reason…
Exploiting different economic growth rates (gaining scale and scope) e) Exploiting product life cycle differences (technology) f) Pursuing potential abroad g) Globalizing for defensive reasons h) Pursuing a global logic or imperative (new markets and profits) - determine the basic long-term goal It means, UGG wants to have a global position, etc Strategies: 1. Organisational resources * Outsourcing: one of the weaknesses of UGG is the limited sheepskin that they are facing. As we understand…
procedures and having auditors with required experience and competence would have decreased the chances of this fraud from occurring. The absence of an effective governanve enabled much of the activity to occur. The constant cover up and reports of profits and were inflated made it harder and harder for Satyam to continue. Internal Controls are designed to promote efficiency and effectiveness of operations, compliance with policies and procedures, and reliability of financial reporting. Because controls…
Far More Than You Bargained for Picture this: you purchase a fake Gucci handbag in Los Angeles for a mere fifty dollars. The invisible, yet oh-so realistic price tag includes an extensive list of crimes and obscenities that greatly outweighs those fifty dollars. Counterfeit goods are far more than cheap imitations of luxury brand items in the realm of fashion. When one purchases such articles, he or she supports indecencies such as child labor and terrorism, as well as countless additional dreadful…
damage and decreased innovation’s efforts (Jain, 1996). This essay will examine the effect of intellectual property leakage on foreign firms in China. It will also analyze the drivers of IP infringement. In China, there is a common joke, “Everything is fake but your mother”. This joke addresses that IP issues are serious in China. Most MNCs are from Western countries especially U.S have very crucial role in contributing China’s foreign direct investment (FDI). MNCs announced that IP protection is their…
which means that the metal can be melted into coins, shotgun shells or even into jewelry. Must of the time gold is changed into coins because it doesn’t rust unlike other metals such as silver and copper. Gold is also a metal that is hard to fake. To fake the shine and quality of gold would be difficult for most people to do. Gold is desired because it is desirable. These are just some of the reasons why many societies around the world choose gold as money. Q2. Gold and Silver paper certificated…
Ethical decision making: A dilemma Ethical issues have greatly transformed in our lives since the great Enron, Xerox and other huge corporations proposed big profits showing earnings of billions of dollars and yet in reality facing bankruptcy. These corporations faced great trouble with the federals and state for manipulating financial statements. But not only corporations can be blamed on this, accounting firms were involved in this as much as the corporations were. With the business stand…
especially to imitate a natural product, not genuine. I will research further into artificial materials and artificial goods such as artificial silk producers and designer bags which maybe too expensive to buy for some, therefore a replica or a fake is produced for a small price. I will pursue further discussion around the effects that synthetics and naturals have on the environment, such as trend which leads to multiple buying and increased disposability. Are synthetics biodegradable like naturals…
GMOs, Helpful of Harmful? Genetically modified organisms, also known as GMOs, make up for majority of the foods being produced today. There are a few to no benefits to these altered and ‘fake’ organisms. GMOs are organisms that have had their gene material altered by a process called genetic engineering. Many serious effects occur to the environment on which they are grown, and to those who consume these ‘alien’ foods. The affects of GMOs may be large or small, in any case, but there are affects…