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No Shortcuts Around the Balance SheetAugust, 2002 THE ENRON CORP. COLLAPSE may have been the "neutron bomb" of accounting problems, but today's financial statements in general can be misleading, according to James Van Horne, the A. P. Giannini Professor of Banking and Finance. Instead of looking to income statements to determine a company's true worth, Van Horne recommends investors pay careful attention to the balance sheet. "In the final analysis, one must turn to an in-depth evaluation of the flow of funds through the balance sheet," Van Horne suggested during a Last Lecture series presentation (see "Parting Words" above). While most of the public attention has been on allegations of fraudulent accounting and business practices at companies like Enron, the problems with income statements go far beyond such egregious examples, he said. "Even without fraud, the financial statement can be misleading." He suggested being wary of an increasing debt ratio, recurring write-offs, multibusiness companies that aggregate sub-businesses to hide information, and unusual quarterly patterns and expenses. Evaluating the balance sheet involves taking the time to check "the conversion of inventories into revenues, then into receivables, and finally into cash. On the other side of the balance sheet, the conversion of purchase orders into accounts payable, and then into the payment of accounts payable, and, ultimately, debit to cash. The combination of these two conversion cycles gives us the overall operating cash cycle of a company." For more details from the lecture, see http://www.gsb.stanford.edu/news/vanhorne.html. |
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