What could be the modus operandi Satyam Computer Services Ltd adopted to overstate profit and cash on its books? A report by a leading foreign broker released in 2004 details how a company can “create earnings per share” by fudging accounts.
In order to report impressive results, a company books notional revenues in its books of accounts, thanks to a planted order from a known company. Since the order is notional, much of it flows into the bottom line and makes profit margins look high.
However, real cash flow will be low because the order is non-existent. The artificially inflated sales and profit sit on the balance sheet as debtors. Since real cash flows are restricted, debt of the company remains high, which also reflects as high interest costs in the profit and loss statements. Although revenue and earnings growth is impressive, the pressure points are high debtors, high debt and interest costs.
Also Read Will Satyam survive the blow?
In the case of Satyam, the story could well have been very similar with respect to notional orders and artificial profit creation, but the way they reflected in the balance sheet is different, at least based on the former chairman’s confessional statement. For Satyam, the artificial created profit sat on the balance sheet as artificial cash primarily, rather than debtors. Unlike when there’s a rise in debtors, market analysts are glad when cash reserves are rising (except, of course, for the complaint that companies should pay out excess cash to shareholders rather than hoard it). But high cash is hardly a bother when compared to rising debtors. This is the reason Satyam’s books didn’t really come under scrutiny from market analysts, since one normally takes the auditor’s word on cash and bank balances.
Of course, this theory holds as far as the confessional statement is true. Indeed, according to the statement, “The differential in the real profits and the one reflected in the books was further accentuated by the fact that the company had to carry additional resources and assets to justify higher level of operations—thereby significantly increasing the costs.”
But it’s equally likely that the profit was always genuine, but cash was siphoned off and is now being covered up with the theory of artificial profit creation.
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