Aggressive Accounting - The Frog in the Pot
There is the story of a frog in the pot. If the water is hot, the frog will jump right out. If it is warm to start, the frog will stay in. As the water keeps getting a little warmer, the frog doesn't notice. Eventually it gets hot and the frog is cooked.
Aggressive accounting can be just like the frog in the pot. The owner gets used to the new numbers. Abnormal becomes the new normal. It feels comfortable like warm water. The owner believes he is doing better than he really is. Instead of facing the pain and using it as leverage and motivation to make real changes, the owner carries on without making real changes to the business that are needed.
What do I mean by aggressive accounting? It is not fraudulent accounting, doing something that is clearly wrong. It is being aggressive where estimates are called for, such as:
- Inventory valuations
- Depreciation- useful life and salvage value
- Accounts receivable- collectibility
- Expense accruals
- Revenue recognition
Over a period of years, just like rising temperature in the pot, the effect of the aggressive accounting builds up. The gap widens between aggressive accounting numbers and results from typical practices.
Eventually the business may be cooked.
- The economy goes south and not even aggressive accounting can save the numbers. The changes in the business needed long get made too late to weather the storm in a tough economy.
- The bank gets acquired or decides not to renew the loan. The new prospective banker doesn't buy in to the accounting and takes a pass on the company.
- The owner goes to sell but the buyer discounts the numbers heavily to put the accounting back in line with industry practices. The business sells for a fraction of what it could have.
When you have to improve your numbers, do it through real improvements. Take a hit on your numbers one year if you have to while you improve the business. Don't play games with the numbers and start digging your grave.
That's some great advice. You never really learn such things in business school. I made that mistake once when i started spending more time playing with the numbers and forgot about merchandising and coming up new ideas for my small business. I learned the hard way and adopted some tools and an accountant to help me with only those numbers that matter. Now, when i look at them after some time i can really tell the difference and drive the changes through other means which reflects.
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