accounting – Pertinent Observations

Financial ratio metrics

It’s funny how random things stick in your head a couple of decades later. I don’t even remember which class in IIMB this was. It surely wasn’t an accounting or a finance class. But it was one in which we learnt about some financial ratios.

I don’t even remember what exactly we had learnt that day (possibly return on invested capital?). I think it was three different financial metrics that can be read off a financial statement, and which then telescope very nicely together to give a fourth metric. I’ve forgotten the details, but I remember the basic concepts.

A decade ago, I used to lecture frequently on how NOT to do data analytics. I had this standard lecture that I called “smelling bullshit” that dealt with common statistical fallacies. Things like correlation-causation, or reasoning with small samples, or selection bias. Or stocks and flows.

One set of slides in that lecture was about not comparing stocks and flows. Most people don’t internalise it. It even seems like you cannot get a job as a journalist if you understand the distinction between stocks and flows. Every other week you see comparisons of someone’s net worth to some country’s GDP, for example. Journalists make a living out of this.

In any case, whenever I would come to these slides, there would always be someone in the audience with a training in finance who would ask “but what about financial ratios? Don’t we constantly divide stocks and flows there?”

And then I would go off into how we would divide a stock by a flow (typically) in finance, but we never compared a stock to a flow. For example, you can think of working capital as a ratio – you take the total receivables on the balance sheet and divide it by the sales in a given period from the income statement, to get “days of working capital”. Note that you are only dividing, not comparing the sales to the receivables. And then you take this ratio (which has dimension “days”) and then compare it across companies or across regions to do your financial analysis.

If you look at financial ratios, a lot of them have dimensions, though sometimes you don’t really notice it (I sometimes say “dimensional analysis is among the most powerful tools in data science”). Asset turnover, for example, is sales in a period divided by assets and has the dimension of inverse time. Inventory (total inventory on BS divided by sales in a period) has a dimension of time. Likewise working capital. Profit margins, however, are dimensionless.

In any case, the other day at work I was trying to come up with a ratio for something. I kept doing gymnastics with numbers on an excel sheet, but without luck. And I had given up.

Nowadays I have started taking afternoon walks at office (whenever I go there), just after I eat lunch (I carry a box of lunch which I eat at my desk, and then go for a walk). And on today’s walk (or was it Tuesday’s?) I realised the shortcomings in my attempts to come up with a metric for whatever I was trying to measure.

I was basically trying too hard to come up with a dimensionless metric and kept coming up with some nonsense or the other. Somewhere during my walk, I thought of finance, and financial metrics. Light bulb lit up.

My mistake had been that I had been trying to come up with something dimensionless. The moment I realised that this metric needs to involve both stocks and flows, I had it. To be honest, I haven’t yet come up with the perfect metric (this is for those colleagues who are reading this and wondering what new metric I’ve come up with), but I’m on my way there.

Since both a stock and a flow need to be measured, the metric is going to be a ratio of both. And it is necessarily going to have dimensions (most likely either time or inverse time).

And if I think about it (again I won’t be able to give specific examples), a lot of metrics in life will follow this pattern – where you take a stock and a flow and divide one by the other. Not just in finance, not just in logistics, not just in data science, it is useful to think of metrics that have dimensions, and express them using those dimensions.

Some product manager (I have a lot of friends in that profession) once told me that a major job of being a product manager is to define metrics. Now I’ll say that dimensional analysis is the most fundamental tool for a product manager.

Startup bragging and exaggeration rights

It seems to be common knowledge that startups like to exaggerate their results when they talk to the media. While I’ve known this for a long time, I was rather startled to see the numbers put out by a company I know, which seems to be an order of magnitude larger than what is actually the case. And when I was discussing with someone else in the know, I was told that this degree of overstating (especially to the media) is a common thing in the startup world.

In “normal” companies, overstatement of numbers is a massive crime, and shareholders can prosecute the management for such activities. Yet, it seems like investors in startups (funded startups seem to do this all the time) don’t seem to mind this at all. What is the difference?

“Normal” steady-state companies usually don’t have to raise capital too often. After they’ve raised a certain amount, hit steady state and gone public, raising more capital is a rare event. Also that they are public means that you have “gullible households” who own equity, and investor protection laws mean that they need to state incomes and other financial information to the best of their knowledge, and any cooking of the books can lead to prosecution.

For a startup, on the other hand, raising capital is a “normal” (as opposed to “extraordinary”) event, and its investors are mostly sophisticated investors (apart from gullible employees who have been forced to take equity for “skin in the game”). By overstating its numbers, especially in the popular media (hopefully now with the Registrar of Companies), startups can hope to create greater buzz which increases the likelihood of getting a next round of investment at a higher valuation.

Notice that in this case investors are also okay with the books having been cooked since they aren’t playing the dividend game but have a short term goal of raising more funds at higher valuations. And if overstating numbers can help that, so be it!

Generalists and specialists

So you have generalists and specialists. Generalists are fundamentally smart people who can do a variety of things. They take a look at a problem, take some time to understand the basics, and then go about solving it. They get bored easily, and move from problem to problem. Generally, they don’t dig deep but are well equipped enough to solve most problems.

Specialists, as the name suggests, dig deep into a particular problem. They are the kings of all they survey within their domain, and know every little trick in the book. However, they are usually unaware of the world outside of their wells, and suffer from the hammer-nail problem (to a man with a hammer, everything looks like a nail). They are also deeply insecure – for if their area of specialization gets invaded by generalists, they are likely to lose their livelihood. So, they are incentivized to build walls, and make it harder for generalists to invade. Generalists don’t have any such problem. Given their nature, if one fort gets invaded, they can soon go ransack another.

The world is dominated by specialists, and they continue to build walls around themselves. Artificial barriers to entry get created (such as “experience requirements”). While this keeps their domains safe, it leads to an increase in transaction costs and overall decrease in efficiency.

Take accounting as an example. In principle, it is not a particularly hard practice. What makes it particularly hard for aspiring accountants is the way you go about becoming an accountant. You need to pass an exam, set by the association of accountants, and then intern under an already qualified accountant (who pays you less than minimum wage) and pass another exam (again set by the association of accountants) in order to practice accounting. The exam and internship are rigorous enough that you need to devote two or more years of your life (full time) in trying to get your charter. All for a profession that is fundamentally fairly intuitive. So that the specialists’ turf is protected (of course the accountants have every incentive to keep the requirements to the charter prohibitively tough – for more chartered accountants would mean more competition and hence less margins).

Another example is in math papers. They are so formula and jargon ridden that it is prohibitively difficult for anyone who is not a full-time mathematician to make much sense of them. While some of the rigour may actually be justified, most of it is for the sake of preserving the mathematicians’ turf. The same applies in general to all peer-reviewed paper publication journals and conferences.

Social scientists are afraid of economists. Financial traders (from a commerce background) are afraid of engineers. In business schools, “marketing students” are afraid of “finance students” (more on this in another post). Their only defence is raising barriers, forming cliques and spewing jargon.

Tear Down The Wall! TEAR DOWN THE WALL!! TEAR DOWN THE WALL!!!

A View From the Other Side

For the first time ever, a few days bck, I was involved in looking at resumes for campus recruitment, and helping people in coming up with a shortlist. These were resumes from IIMB and we were looking to recruit for the summer internship. Feeling slightly jobless, I ended up taking more than my fair share of CVs to evaluate. Some pertinent observations

There was simply way too much information on peoples’ CVs. I found it stressful trying to hunt down pieces of information that would be relevant for the job that I was recruiting for. IIMB restricts CVs to one page, but even that, I felt, was too much. Considering I was doing some 30 CVs at a page a minute, I suppose you know how tough things can be!
The CVs were too boring. The standard format certainly didn’t help. And the same order that people followed -undergrad scores followed by workex followed by “positions of responsibility” etc. Gave me a headache!
People simply didn’t put in enough effort to make things stand out. IIMB people overdo the bolding thing (I’m also guilty of that), thus devaluing it. And these guys used no other methods to make things stand out. Even if they’d done something outstanding in their lives, one had to dig through the CV to find it..
There was way too much irrelevant info. In their effort to fill a page and fill some standard columns, people ended up writing really lame stuff. Like how they had led their wing football team in the intra-hostel tournament. Immense wtfness. Most times this ended up devaluing the CV
Most CVs were “standard”. It was clear that people didn’t make an effort to apply to us! Most people had sent us their “finance CV” but would you send the same CV for an accounting job as you will for a quant job? Ok yeah I understand this is summers, but if I see a CV with priorities elsewhere, I won’t shortlist them!
By putting in several rounds of resume checking and resume workshops, IIMB is doing a major disservice to recruiters. What we see are some average potential corporate whores, not the idiosyncracies of the candidates. Recruiting was so much more fun when I’d gone to IITM three years back. Such free-spirited CVs and all that! This one is too sanitised for comfort. Give me naughtyboy123@yahoo.com any day
People should realize that campus recruitment is different from applying laterally. In the latter, yours is one of the few CVs that the recruiter is looking at and can hence devote much more time going through the details. Unfortunately this luxury is not there when one has to shortlist 20 out of 180 or so, so you need to tailor your CVs better. You need to be more crisp and to the point, and really highlight your best stuff. And if possible, to try and break out of standard formatI admit my CV doesn’t look drastically different from the time it did when I was in campus (apart from half a page of workex that got added), but I think even there I would make sure I put a couple of strongly differentiating points right on top, and hopefully save the recruiter the trouble of going through the whole thing.
I think I’m repeating myself on this but people need to realize that recruiters don’t care at all about your extra-currics unless you’ve done something absolutely spectacular, or if there is some really strong thread running through that section. So you don’t need to write about all the certificates that you have in your file

The bottom line is that recruitment is a hard job, especially when you have to bring down a list of 200 to 20 in very quick time. So do what you can to make the recruiter’s job easy. Else he’ll just end up putting NED and pack you.

Why is Ten Sports sitting on so many rights?

I wanted to stay up last night. I wanted to stay up and watch the WI-Eng match till the very end. Waking up this morning and checking the scorecard, it seems like it was a really good match. And Fidel Edwards seems to have become a last-day-shutdown specialist. This is the second time this series he’s hung on. And he’d done so once before against India at ARG.

There was another reason I wanted to stay up last night. I wanted to watch Liverpool play Real Madrid. I woke up this morning and saw that it was an amazing game, too. Looking through the Guardian Football site (btw, Advani seems to be advertising heavily on that site; it’s a pity he never advertises here on my site) I noticed that Chelski-Juve was also a strong game, despite the result. Another reason I would’ve wanted to stay up last night. For the record, I slept at 12:10. Tea-time in the Test match, and before either of the football games had started.

Ten Sports seems to have bitten off more than it can chew. It seems to own the rights to telecast too many different things. I think I have raised this point once earlier, but it pzzles me as to what Ten Sports is trying to achieve by getting rights to telecast so many things, most of which are happening at the same time. For example, over the last couple of weeks I’ve been unable to watch the first hour of WI-Eng even if I’d wanted to, because it was overlapping with the last hour of SA-Aus, which was being telecast at the same time.

The reason I slept off early last night was because I didn’t have the option to watch what I wanted. All the three games that I’d’ve been reasonably interested in were supposed to be on Ten Sports (Zee Sports doesn’t count since Tata Sky doesn’t offer that), and I realized that I’d be forced to watch what the guys at the Taj Entertainment Network would want me to watch. Denied the option to choose what I wanted to watch, I went to bed.

It puzzles me that Ten Sports isn’t subletting its contracts. Devoid of anything decent to show, I suppose that ESPN or NEO would’ve only been too happy to acquire the rights to telecast last night’s Liv-Real game by paying a fee to Ten Sports. And it would’ve unlocked value at the hands of the remote-holder. Ten Sports need not let go of the rights to show all the games. All they need to do is to sell the “out of money options” – the rights to the game which they won’t be able to telecast anyway.

Now, the problem will be if accounting for all costs, no options are out of money. For example, you know you won’t be able to show Liv-Real. But you think that the loss of brand equity of your channel would exceed the money you’d gain by selling this option to another willing channel. The viewers are the only losers at this game, but I don’t know what can be done. After all, viewers are way too dispersed in order for them to take any kind of action.

Extending this question, what can a sports body do to prevent a bidder from acquiring rights to telecast and then mess up the telecast (or not telecast it at all) ? After all, the sports body is out there to make as much money as possible from the TV rights, and they need to ensure significant investment into broadcasting by the broadcasters, so the “i’ll give rights to only those channels that are in the interest of the people” model won’t work.

One option would be to sell the rights to two channels in each market. But given that broadcast is a natural monopoly, the sports body will not be able to make as much by selling to two bidders as it can by selling to one bidder. Is there any other solution that you can think of? If yes, unleash.

What rate of interest did Kubera charge?

It is fairly well established that Tirupati Venkataramana (it is Venkataramana and not Venkateshwara – remember that it is a Vaishnavite temple) took a loan from Kubera in order to finance his wedding to Padmavati. And till date, Venkatarmana has been soliciting contributions from visitors to his shrine in order to help him pay off this loan. Given that the loan was for the purpose of getting married, I think we can quickly establish that it was a Personal Loan. What I’m trying to figure out, however, is what rate of interst did Kubera charge Venkataramana.

For starters, I think somewhere in our scriptures, we can find out the amount that Venkataramana borrowed. Rupees didn’t exist in that era, but I’m sure we can find some figures in terms of gold, or other commodities. And we should be able to estimate the rupee value of this loan by suitable backward extrapolation.

What might be slightly tougher is the time period. When did Kubera exist? When did Venkataramana exist? When did he get married to Padmavati? The date is important, for we should know how many years to discount for when we do the IRR calculations. However, I’m sure that with sufficient effort, we should be able to find the date of this particular transaction to the nearest millenium.

Then, there are the loan repayments. Let us assume that Venkataramana is in general a poor man, and his repayments can be approximated to the amount of offerings he receives from visitors to his shrine. Catch a few people sitting for McKinsey interviews, and estimating this amount is also not going to be very tough. We should be able to get fairly accurate figures for the last few years, and then we should be able to appropriately extrapolate backwards accounting for various regime changes (I’m assuming here that the temple, for whatever reason, will refuse to cooperate in this noble endeavour – else we can get the repayment amounts from the temple books).

We also need to remember that the repayment is not complete. People still contribute generously to the Venkataramana Personal Loan Repayment Fund. However, if we assume that the loan has already been repaid, we can get a floor on the rate of interest that Kubera charged. It is intuitive right – that if more money pours in, the interest rate would’ve been higher? Let us also assume that there were no repayments till about five hundred years ago, which was approximately when the temple was built. Assuming zero repayments till then, it again gives a floor on the interest rate.

Obviously, I don’t already have any of the data that I’ve mentioned here, so I can’t actually do the calculations. However, if McKinsey decides to solve this problem, they can do so in March during their interviews at IIMs. My prediction, however, is that the rate of interest will come out to be a number which, in normal circumstances, would be found to be usurious. Thus, we might probably be able to show that people are contributing to funding a greedy usurious rich moneylender when they contribute to the Venkataramana Personal Loan Repayment Fund. I don’t know what further use this might be put to, but I think the process will be an end in itself.

On a closing note, I would like to point out the greatness of our culture – which, even in mythological times, could boast of complicated financial products such as Personal Loans. This one factor, I think, is enough to show that our Indian culture is superior to all other cultures.

PS: Sometime back, I was wondering if the Venkataramana Personal Loan Repayment Fund could be the largest money-laundering operation in India. However, a little thinking revealed that our political parties are definitely far far ahead when it comes to that.