Cash is King, Again

GAAP accounting assumes and insists that there exists within the firm a realistic matching of revenue and expense. This notion makes sense, particularly if someone is looking at the firm’s financial statements and wants to understand the firm’s revenues or expenses during a specific period of time, say for a month, or a quarter or a year. Investors and lenders are especially interested.

Subsequent to this notion, GAAP includes all sorts of accounting rules about inventory valuation methods, that is, FIFO or LIFO, etc. This matching concept likewise affects the inventory movement valuation which becomes part of the cost of sales line item, as a firm must sell inventory on hand in order to have recognized sales.

Let me wax more specific. One client of mine spent $60,000 out-of-pocket to manufacture 15,000 units of an item the firm then sold at a rate of 1,500 to 2,000 units a month at a retail price many times the cost. If the entire $60,000 were recognized as cost of sales expense immediately, then we might have an operating statement loss in the month the $60,000 is spent to buy inventory and a gain in every future month that those items are sold. Instead, this product is inventoried and appropriately parceled out, therefore appropriately matching revenues and expenses per GAAP rules.

The GAAP matching rule helps negate these kinds of distortions. We might wonder though, is there a trade-off? There are also GAAP accounting rules to follow regarding recognizing depreciation expenses in a specific accounting period, because depreciation expenses definitely affect the operating profit or operating loss for a specific period, whether we use straight-line depreciation or some accelerated depreciation method.

Likewise, according to GAAP, payroll expenses paid on a weekly and/or bi-weekly and/or bi-monthly basis, must be matched with accrued vacation, etc. That means payroll expenses, including accrued vacation, must be spread across accounting periods, appropriately, because of the same necessity of matching revenues and expenses to avoid distorting financial statements. There are other cross-period expenses incurred as well.

However, closely following GAAP accounting rules does not necessarily mean that the long-term sustainability and profitability of the firm is enhanced. In fact, somewhat the opposite may happen, especially if the accounting tail is inappropriately wagging the dog. One answer to the trade-off question asked above may be less critical focus on cash flow.

One small business firm client actually reduced their total accounting expenses from 3% of total revenue to less than 2% of total revenue, while overall revenue shrank, becoming more profitable and not missing a beat. This increase in profit is attributed to more than the simplification of accounting software, of course.

The benefit accrued mostly by paying careful attention to actual cash flow together with forecasted cash flow, instead of harboring concern whether there were sufficient accounting personnel on hand to carefully match revenues and expenses according to GAAP.

This is not to denigrate GAAP accounting, but in today’s world where financial institutions in America (2009 – 2011) are typically not lending to small business, why spend money on prettifying the financial statements when a loan from a financial institution may not be forthcoming anyway?

I am not suggesting ignoring GAAP accounting rules at all, nor saying a firm ought not to use a CPA firm to file Tax Form 1120 (or whatever form is appropriate) with the IRS annually, but instead proposing that as most successful business owners know, it is focusing on cash flow that will make or break their firms, not anything else.

If you closely analyze your cash flow forecast and know during which weeks you will likely be light on cash and which weeks you will be more likely to be flush with cash, then a business owner can speak to their vendors with conviction and accuracy, improving his credibility. The same applies to staging and staggering one’s major purchases of inventory.

Purchasing nine to twelve months of inventory at one time requires intimate familiarity with your cash flow. Can you the business owner afford not to know where your cash flow likely will be each week for one month or two months into the future?

Instead of only using accounting personnel to massage past transactions, spending non-essential hours daily complying with GAAP accounting rules, why not re-task these same accounting people to help to create a future of the business owner’s choosing?

A Working Definition of Right-leaning versus Left-leaning

The Problem  

One of my economic students had a problem dealing with the many definitions circulating that attempt to describe what it means to be either right-leaning or left-leaning, in a political sense. She was confused trying to discern among the many voices she was hearing. For instance, many people today label the mainstream media as mostly left-leaning. What does that mean and does it matter?

That student wondered whether or not they should care if a news article is written from a right-leaning or left-leaning perspective, as long as the facts are correct. Bernard Goldberg wrote a good book about this subject, which book I recommend, called Bias. Please read the book, if you want a more detailed explanation as to why Goldberg thinks the journalist’s political perspective matters plenty.

My present intention is simply to distill the various arguments being made into a few useful identifiers that will allow clarity to enter this dialogue.

Left-leaning –

Wants larger government;

Looks for and supports government solutions to social and business problems;

Looks for additional government regulation;

Looks for government intervention in market prices, that is, setting price floors and price ceilings;

Looks for equality of results;

Sees government as the source of “rights”;

Sees government as enforcer;

Prefers the comfort of knowing what to expect;

Right-leaning –

Wants smaller government;

Looks for individual or market solutions to social problems;

Looks for less government regulation;

Likes the price signal sent by prices generated through relatively unfettered market competition and supply and demand interaction;

Looks for equality of opportunity;

Sees government as protector of “rights” that exist without government say so;

Sees government as a referee of a reasonable rule-of-law;

Enjoys the messiness of freedom and uncertainty;

Conclusion

Whatever the arguments espoused by so-called conservative politicians, or progressive politicians, or liberal politicians or ‘tea-party’ politicians, does not make their proposal left-leaning or right-leaning, as the fact is that a left-leaning politician can champion a right-leaning policy and a right-leaning politician can fight for a left-leaning policy.

What is useful to know is whether the policy being pushed is either right-leaning or left-leaning. Policies, not politicians determine the ‘leaning’ nature of the political ideology of the idea under consideration. Using this working definition provides all of us an easy way to measure the political bearing of political arguments and discussions.

Please allow me to differentiate between reasonable government regulation enforced under a reasonable rule-of-law, with government administered justice applied blindly and evenly to all offenders and government price intervention – which government price intervention by definition is a left-leaning policy. This is not the same as the government serving as a referee or an enforcer of a reasonable rule-of-law. The phrase “government intervention” is sometimes inappropriately applied to government regulation.

The founding fathers set up a limited government, which is not necessarily the same as a small government. To ascertain the right-leaning and left-leaning nature of a policy requires we must first look at the facts on the ground today and then choose how we move the American Economy to a different point in the future by implementing policy.

There absolutely must be reasonable government regulations applied appropriately to free market transactions operating with a reasonable rule-of-law and this notion of reasonable regulation is not really a right-leaning or left-leaning issue, per se.

Like Richard Epstein points out, he is not a Libertarian calling for zero government regulation. Instead Epstein and each of us wants to have what each of us judges to be the right level of government regulation, to make free markets work the most efficiently and effectively they can.

 

Defrauding the Government in Pittsburgh, Pennsylvania

An online MBA candidate related the following fraud story:

In 2008, an employee hoping to hide personal funds from the government hid the money in a company trust fund in order to gain personal government benefits. After ownership of the money would no longer affect receipt of those government benefits, the money was removed from the trust fund and given back to the employee.

The owner of the company was aware of this transaction as was his high-level employee who handled the trust accounts, placed the money, then later retrieved it. The controller was also aware of this fraudulent transaction, but none of them reported anything amiss.

Interesting Economic Fact – Oil Sources for America

Interesting Economic Fact – Oil Sources for America

The USA used approximately 19.1 million barrels of oil a day in 2011, importing around 9.5 million barrels of oil daily. The top ten countries importing oil into the USA (millions of barrels) were:

Canada                  2.2

Saudi Arabia       1.2

Mexico                  1.1

Venezuela            0.9

Nigeria                  0.8

Iraq                       0.5

Colombia            0.4

Angola                 0.3

Russia                   0.2

Brazil                    0.2

Reference: DOE & CIA

These ten countries accounted for more than 80% of 9.5 million barrels of oil imported into the United States every day. Please note that none of these countries are hostile to America. However, oil, like money, is fungible.

What does the fact that oil is fungible mean? Fungi-ability (newly coined word) means that because these relatively friendly nations are exporting their excess oil to the United States, other industrial nations like Japan, China and nearly all the countries in the European Community must import their daily oil from countries much less friendly to the United States like Iran and Yemen.

Therefore, it can be reasonably argued that because of the huge demand that the US creates for global oil, the United States really is, at least secondarily, with oil money, helping fund terrorists that attack America and American interests. Perhaps if the United States were able to stop importing oil and instead use domestic oil exclusively, the terrorists would not have sufficient money available to attack America.

Adding together the known oil in ANWR in Alaska, plus known continental shelf oil deposits just off the coasts of America and including the Rocky Mountain shale oil deposits totals approximately 2 trillion barrels equivalent of recoverable oil. If we Americans chose to recover oil from these three sources alone, assuming a 20-million-oil-barrel-usage-run-rate per day, then America could be self-sufficient in petroleum for at least 274 years!

Two important questions must be considered:

1) Could this oil be recovered in an environmentally-sensitive fashion?

Yes, relatively easily.

2) Does the necessary political will exist to recover this domestioc oil?

No, it does not.

How to make the economy go zoooom in the night. Part 1 of 2

Practical Economics:  

How to make the economy go zoooom in the night.

The main determinants of long-term economic prosperity and growth are explained.

Part 1 of 2

ECONOMIC PROSPERITY

A major factor involved in the growth and prosperity of a nation today is whether or not the culture within that nation encourages and rewards the acquisition of knowledge. By knowledge I mean a broad definition including manufacturing skills, technical know-how, an ability to learn by doing, all combined with leading-edge information gained from intense investigation.

A useful example of this is the knowledge that the human genome project provided the world, for instance.

Over a decade has passed since scientists successfully mapped the entire human genome in 2001, yet the incredible benefits flowing already throughout the world today are likely just a minor trickle compared to the major benefits yet to be enjoyed tomorrow from that tremendous effort. Every day brings new genes being analyzed as possible culprits causing this or that affliction, afflictions once thought to be and once accepted as a normal part of the human condition.

My contention is that if the educational framework within a country allows sufficient positive incentive (read: economic profit) to acquire knowledge such as research and development skills and technological know-how, then a country can vastly improve the human capital side of production.

Therefore, this kind of knowledge acquisition can enhance the added value of the labor factor many, many times, wonderfully magnifying standards of living in that country.

EDUCATION IN CHINA & JAPAN

The economy that has grown the fastest over the past 30 years has been China. The Chinese economy is now the 2nd largest in the world. To be sure, market forces have been unleashed in China, but economic freedom is an after-effect and only a partial explanation, not the underlying cause of Chinese economic prosperity, I think.

Perhaps a better fitting explanation is that education is highly prized in China and has been for at least 2000 years. The pursuit of knowledge is perceived to be a high value to most of the citizens of China. And millions of Chinese have become well-to-do during the last three decades.

Centuries ago, long before America was even an idea, China was selecting provincial governors and filling related political positions based on who finished first on nation-wide tests that required memorizing entire books over a period of 15 or more years. Admittedly, the Chinese emperors may have had ulterior motives championing their citizens’ education as their brightest students became part of the political bureaucracy instead of potential revolutionaries bringing down the empire. 🙂

In his book As The Future Catches You, Juan Enriquez, once the director of the Life Science Project at Harvard University, identifies the global economy as rapidly becoming a knowledge economy. He suggests that the determining factor for economic well-being in the 21st century will be how well a nation can apply their citizens’ collective knowledge to their country’s cumulative goods and services output.

Japan, the former 2nd largest economy in the world, recently exceeded by China, with 10 times more people, excels at applying knowledge to their Gross Domestic Product (GDP) and has grown robustly for most of the last 60 years.

PURSUING KNOWLEDGE

In other words, in order for a country to gain and sustain economic prosperity for the long-term, that nation’s citizens must recognize the pursuit and acquisition of knowledge to be a real value. Therefore, that nation’s culture must perceive gaining and learning new information and new skills as a benefit worth the cost.

Unfortunately, the pursuit of knowledge that makes real differences to a nation’s economic well-being is neither short-term, nor painless. In fact, a real difference may take a decade or two or more to show up. Since most politicians’ planning horizon is much shorter (the next election), anyone hoping for political help is likely to be disappointed. Geoff Colvin, in the most recent Fortune magazine (4/9/12, p53) points out that neither Barack Obama nor Mitt Romney offer relevant education solutions to the issues outlined herein.

If politicians cannot help, then who or what can help? The Harvard economists Goldin and Katz argue in their book The Race Between Education and Technology, that the American economy continually demands higher-level skills from workers.

If we assume SAT scores to be a reasonable approximation for knowledge acquisition, then Americans should be unhappy. Looking broadly at the SAT scores of American High School graduates who go on to college from 1970 to 2010, one notes that the SAT scores in Reading and Math have largely decreased over this period. This decrease means American technological companies need to go abroad to find workers with advanced skills or go without.

My contention is that instead of being overly concerned with short-term economic happenings, Americans will have a greater impact on long-term future economic health by focusing on the acquisition of real knowledge among our nation’s citizens.

This means that as painful as many American children may find acquiring math and science mastery during their K-12 years, it turns out that math and science capability have proven to be the main building blocks for technological development over the last 50 years throughout the world. Technological development lowers the economic cost of production inputs while raising the number of units being produced. This is the classic definition of economic productivity. Economic productivity IS the driver of long-term economic prosperity.

CONCLUSION

May I pass on one telling example from Juan Enriquez’ book? In 1985, Mexicans were granted 35 patents from the US Patent Office while South Koreans received 50 or close to the same number. Just thirteen years later, in 1998 the US patent office granted South Koreans 3,362 patents while granting 77 patents to Mexicans. The impact of this significant difference is astounding. The real economic growth rate of South Korea from 1990 to 1998 was eight times larger than Mexico’s.

People are not born able to create patent-able discoveries or processes. Why was South Korea able to outpace Mexico in economic growth so dramatically? Education is emphasized culturally in South Korea much more than it is in Mexico, just as education and the pursuit of knowledge is emphasized in many Asian countries today.

The dramatic emphasis on K-12 education in some countries, including a mastery of basic math and science directly results in faster technological development. The long-term economic benefits stemming from hands-on technological development are almost too numerous to grasp.  

Consider the smart phone, the Kindle and the iPad and the dramatic profitable growth of the companies Amazon, Apple and Google during the past decade, for example. Truly amazing, I think. One might wonder whether math and science mastery during K-12 education can be over-emphasized. 

 Part 2 of 2 of Practical Economics will discuss and analyze the tax and regulatory environment related to gain and sustain long-term economic prosperity. 

The Main Causes of the Housing Crisis and the Financial Meltdown

Previous student question:
For years, I have always believed that some of the government regulation in place has not worked well and has distorted the economy and the financial market.

I also feel the problem of the current weak economy and the on-going housing troubles includes regulatory inadequacy. Is there no regulation in place when it comes to the mortgage industry? If there is, then why did the banking regulators in 2008 look the other way when mortgages were given to people who were unable to afford the loan or unable to understand the fine print? 

My response:

The politicians in charge of executing the banking regulations and in charge of the banking regulators were doing three things that interfered with their ability to enforce a reasonable rule-of-law. One does not find much mention of these activities in the left-leaning, economically-challenged mainstream media. Did you know that a significant number of new mortgages issued during the few years prior to the housing collapse were indirectly sponsored by the government?

1) Those same politicians were accepting political contributions (conflict-of-interest?) from the very mortgage-holding organizations, Fannie Mae and Freddie Mac, two Government-Sponsored Enterprises or GSEs, those politicians were supposed to be regulating. If one checks the facts and follows the money, they will notice that the prominent politicians Chris Dodd (Chairman of the Senate Banking Committee 2007- 2011), Barney Frank (Chairman of the House Financial Services Committee 2007 – 2011), and Barack Obama (Member of the Senate sub-committee on Federal Financial Management 2004 – 2008) were among large recipients of these monies in the mid-2000s.

2) Those same politicians were also insisting that American banks comply with banking laws that used skin color or last names or geographical locations as the criteria for banks to loan mortgage money instead of insisting banks ascertain whether or not these types of new clients were likely to be able to repay the mortgage loan.

3) You are correct that these politicians were looking the other way because they were worrying about whether they were pandering well enough (the real reason for passing ethnic-group membership banking laws) to earn re-election exactly when the voices of many were urging immediate action, because they could clearly see that Fannie Mae and Freddie Mac were near collapse. Do we need new and better banking regulations? Perhaps we do. Do we need better enforcement of the reasonable banking regulations already in place? Of course we do.

Consequences

Passing new, tough legislation can be spun by a politician to show that the politician is doing something about an obvious problem. On the other hand, simple enforcement of reasonable regulations is not sexy, nor is it helpful to extracting maximum political contributions from those entities being regulated. (See numbers 1 and 2 above.)

The three political activities enumerated above contributed mightily to the financial crisis that we Americans are still mired in. Oh yes, there is always “greed” or the normal capitalistic draw of profit to be made (Adam Smith call this draw, “self-interest”), but that incentive is mostly a constant, while what I cited above is what I see as the primary reasons causing the housing and financial crisis. The notion of profit to be made did not change much and is what it always should be in a capitalistic society.

Making more profit is only a secondary cause of the current housing and financial crisis. But please notice who is mostly blamed — the secondary contributor, i.e., the banks seeking profit, when the primary culprits (greedy politicians) are let off the hook by the left-leaning, economically-challenged mainstream media.