Accounting Changes Cloud Assessment of Crisis Impact on European Companies
Excerpts from Mind the GAAP: Reflections on European Corporates’ Results for H1 2009
Accounting limitations make it difficult to assess how the worst economic crisis since the Great Depression has affected the financial health of Europe’s largest non-financial companies, according to Moody’s Investors Service
Financial reports covering the first half of 2009 are a stark contrast of carnage in the income statement, and relative calm and constancy in the cash flow statement and balance sheet.
Moody’s report explains why the 49% median decline in bottom-line profit, the 4% increase in operating cash flow and the largely unchanged balance sheets reported by a sample of 38 firms selected from eight different industries are not particularly helpful when assessing the damage done by the economic crisis.
“Balance sheets of non-financial companies are not necessarily good indicators of changes in financial health — they largely reflect historical costs that tend to be disconnected from the real value of the entity’s assets. Cash flow statements are heavily affected by changes in the inventory cycle and management policy. And one-off items, combined with a smattering of accounting anomalies, can easily cloud the income statement,” says Trevor Pijper, a Moody’s Vice President-Senior Credit Officer and author of the report.
Moody’s study points out that the vast majority of the companies included in the sample — 29 out of 38 — published an additional unofficial figure for net income. According to Mr Pijper, there was limited consistency in the way the alternative “non-GAAP” performance measures were calculated, but they generally portrayed a more favourable outcome than that computed under IFRS.
FFO (’Funds from Operations’) — a measure of normalised cash generation — overcomes many of the accounting limitations described in the report. It automatically excludes one-off items such as disposal gains and impairment charges, as well as other non-cash items. It is also impervious to changes in the inventory cycle. The median decline in FFO was 28%, a significant deterioration but an outcome that prompted Moody’s to lower the rating of only one issuer in the 38-company sample. Set against the rating agency’s expectations, there were few surprises in the half-year results.
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