Friday, September 12, 2008

Another one bites the dust!

Freddie Mercury is probably raring to come out of his grave and sing that song on Wall Street this year.  Its Lehman this weekend, looking for a government bail out.  

The interesting thing though is that Lehman, like other financial companies, has adopted a strange accounting rule, FAS 159, which lets companies show decrease in the market value of their debt due to a decrease in their creditworthiness as an income gain in their P&L. This is truly fascinating and non-common sensical. See this link for some details

Why is this relevant ? It is relevant because if you take into account the the "fictitious income" arising out of this accounting jugglery the income statements  start to look really bad. For instance for the quarter ending Feb 08 the net income for Lehman will go into red sans this income. For income statements see here 

One interesting quote I remember from my accounting and coporate finance class is that you can never get a complete picture from just one of the financial statements - in this case the income statement. You have to look very closely at the balance sheet as well. The quality of assets and liabilities is critically important to the future earning potential of any Company. Earnings statement is just an indicator of past performance. Some of these get highlighted in these turbulent times. 

High time we look at balance sheets of the all the companies more carefully and do not get swayed by dog and pony show of quarterly earnings.

1 comment:

Sarang Sista said...

I totally agree about the need to look into balance Sheet as well as the income and cash flow statements. Just the thing being taught in our Financial Reporting Class. Interesting example with Lehman. You have inspired me into looking into their balance sheet and income statement.