Misleading Financial Indicators

What do crime statistics and business metrics have in common? I was recently reading about the possible manipulation of statistics for a city’s crime rates, and that got me to thinking about how a similar thing happens with a business’s financial indicators.

Like What?

Sometime a particular statistic is highly misleading. For example, a manager who is responsible for increasing sales may indeed be able to report that sales for the month, or quarter, or year or whatever time period were up a significant percent over the prior year’s comparable period. Or, they may say that one month or quarter is up over the previous one. While that may be true, let’s just dig a little deeper to see if this is as good news as it at first appears.

Let’s say that sales increased 30% in the current year over the prior year. Sounds like a good financial indicator, right? But, what if increased sales came at the cost of slower collection of receivables because the additional sales were to financially weaker customers? Or, what if it was achieved via much lower margins? While either might be acceptable, they could also be a sign of troubles to come. Never forget, not all sales are created equal. In the case of monthly or quarterly sales being higher than the prior month or quarter, does this reflect the effect of seasonality or unique circumstances? Consider the case where sales are significantly higher for one month over the prior, but the real reason had to do with bad weather in the previous month. Is that really a big accomplishment? A company’s financial indicators need to be viewed in context and frequently require more analysis.

Another example could be on the cost side. Imagine a department has managed to reduce expenses dramatically. Well, if that means slower production, slower shipping, slower reporting, or some other deterioration in processes, is the cost reduction necessarily a good thing?

An Old Saying

You’ve likely heard the saying, “Figures don’t lie, but liars figure” attributed to Mark Twain. How true, and the above indicate something similar. Well, actually I’m not necessarily saying the people reporting this information are lying, merely that financial indicators considered in isolation may be misleading. So, before you accept a piece of statistical data, consider whether you need to look behind it to see why it is what it is.

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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