Illinois Business Journal - Stability boils down to cash, not reported earnings

With all of the corporate bookkeeping scandals in the air, the professionals who rely upon accurate numbers could be getting the jitters about what they see. But that's not the case.

Bankers and investment advisors are quick to point out that no matter how inaccurately a company's earnings are reported, it doesn't really matter to them because those aren't the figures they're looking at anyway.

"We look at cash flow rates of return, not earnings," said Gordon Johnson of Investment Counselors Inc. "We think earnings are a figment of an accountant's imagination. You can make cash into fraud, but you can't cover up cash."

Johnson and other financial advisors agree that the rules differ depending on which answer you're looking for. The income tax figure is going to differ from the earnings figure.

"We're seeing a scenario in which members of Congress are asking uninformed questions," he said. "Generally Accepted Accounting Principles, for example, pertain to how a company accounts for business, not the way a company does business. What we try to do, as an investment advisory firm, is clean up as many accounting distortions as we can and focus on what does matter."

The stuff that matters, Johnson says, boils down to two material pieces of information: What the company's or individual's assets are worth today, including adjustments for inflation; and how much cash the company or individual has coming, under the assumption that revenue equals gross cash flow.

"We don't factor in any depreciation or goodwill, non-cash items," he said. Charles Levin, a partner in the Chicago-based corporate law firm McDermott Will & Emery, said there is definitely some "off-balance sheet stuff" going on, along with a wide variance in how trading activities are being valued when they land on the company's balance sheet.

"There is little motivation among private companies to show income that isn't there, but one (reason) is to make bankers happy," Levin said.

A sluggish economy, area bankers say, lessens a firm's need to borrow money because that firm's own business has contracted in harder times. And that contraction is helping tighten credit and has given banks a chance to discern the good credit risks from the bad.

Levin cautioned banks not to dispatch field auditors who have more experience in looking at collateral than they do examining accounting nuances.

And expect the "craziness over options" to intensify, Johnson says, as Congress continues in its quest to pass legislation allowing corporations to record their stock options as expense entries on the books.

Johnson's firm and others in the industry are not buying into the frenzy.

"We're on the side that it is already accounted for properly on the balance sheet," he said. "When you give someone an option instead of compensation, Congress is saying you should be able to expense it. But we say no, because that option is not cash. It's merely a dilution of the company's earnings. And it does not belong on the company's income statement, either. Options are an unintended consequence of stupid legislation."

Johnson said business execs should listen for the new Wall Street catchword - visibility.

"Visibility is the new catchword for what they see for the future, what the next quarter looks like," he said. "Two or three years ago, people had 'visibility' forever in good times. Today, that 'visibility' is clouded."

Another accounting term gaining popularity on the horizon, Johnson said, is "earnings before options."

On Sept. 30, Allegiant Bancorp Inc. will officially acquire Investment Counselors Inc. Investment Counselors Inc. will become a wholly owned subsidiary of Allegiant Bancorp Inc. and will be renamed Allegiant Investment Counselors. The transaction is subject to regulatory approvals.

Allegiant Bancorp Inc. is the parent company of Allegiant Bank, Bank of Ste. Genevieve and State Bank of Jefferson County, Mo.