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What we expect from the businesses we invest in #2: Company accounts

30/03/2017

Simon Adler

Simon Adler

Fund Manager, Equity Value

As investors, we take our responsibilities very seriously – and we believe the companies we own shares in should too. This is what we expect from them when it comes to corporate accounting practices

The surprise on the faces of company executives when we tell them we do not intend simply to rubber-stamp whatever course of action they may be proposing at the next shareholder meeting has led us to conclude we should explicitly set out the sort of behaviour we would like to see from the businesses in which we invest, how we measure that behaviour and how we would react if we did not like what we saw.

One common technique we noted, to which companies – aided by their auditors – are increasingly resorting is the deliberate obfuscation of accounts. Some businesses are becoming very skilled at making life as difficult as possible for anyone trying to dig into and reconcile their finances – for example, through joint ventures, associates and minorities and the use of ‘other’ sections in their accounts.

Another practice is the use of ‘exceptionals’, which companies use as a way of claiming unhelpful numbers in their accounts are merely one-offs. This is a practice we find especially unsavoury when remuneration structures are based on supposedly ‘core’ profits.

However these are not the only ones. At the risk of being the most boring article (we’ve) ever written because we spend a great deal of time poring over the previous 10 years of a typical company’s accounts here is the list of behaviours we would like to see in them going forward please. There will be more but here is a starter:

 

Focusing on the long term

  • Stop quarterly reporting. We would encourage our investments not to report quarterly profits as we believe the focus should be on the long term not a 12 week reporting period.

 

Greater disclosure

  • JV (joint venture) and associate profit not included in operating profit and shown per JV and associate
  • JV and associate summary profit and loss, balance sheets and cash flows
  • Exceptionals split into cash and non-cash
    • Equal disclosure of positive and negative exceptionals in the year they are taken
  • Gross and net operating lease charges
    • Average lease length to breaks and in total
  • Net debt reconciliation showing items such as changes from acquired or disposed cash and debt and the detailed impact of foreign exchange
  • Credit books – where companies provide credit to their customers we’d like them to show the credit book moves through the year including new lending, new provisions taken and the use of provisions
  • Year end share count and average price of any buy-backs that have been done
  • Show the profits of any businesses acquired in the previous two years separately
  • Factoring of working capital – disclosure of what has been factored and how that has changed through the year. Ideally including the terms of the factoring.

 

Basic accounting

  • Interest income shouldn’t go into revenue (one of the very biggest companies in the UK does this!)
  • Operating cash flow to be in the cash flow statement not in a separate note
    • We would like cash interest received and paid to be in cash flow from operations and nowhere else
  • Not aggregating different lines of accounts – we don’t mind the length of accounts and we don’t like pension and provisions, for example, being put into one line
  • Other lines shouldn’t exist – we’d like to see what ‘other’ is
  • Include Total Aquisition Expenditure including share issuance, contingent liabilities and debt assumed.
    • These should all be an all-in gross number broken down into cash and non-cash.

 

Re-statements

      • If companies insist on re-stating prior year accounts please provide the original reported numbers alongside the new ones and a reconciliation between the two

 

Here on The Value Perspective, we feel we have a duty to try and stop the rot and encourage businesses to behave better. If we believe the accounting of a business in which we hold shares is not up to the appropriate standard, we will first write to it and explain why and, if no good reason is given or there is no improvement by the next company report, we will vote against the accounts, the chief financial officer and the audit committee. As company investors, we take our responsibilities very seriously; as company executives, they should too.

Author

Simon Adler

Simon Adler

Fund Manager, Equity Value

I joined Schroders in 2008 as an analyst in the UK equity team, ultimately analysing the Media, Transport, Leisure, Chemicals and Utility sectors. In 2014 I moved into a fund management role and have had experience managing Global ESG and Pan-European funds.  I joined the Value investment team in July 2016 to focus on UK institutional and ethical-value portfolios.

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The views and opinions displayed are those of Ian Kelly, Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans and Simon Adler, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated. They do not necessarily represent views expressed or reflected in other Schroders' communications, strategies or funds. The Team has expressed its own views and opinions on this website and these may change.

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