David Copperfield and his troops are masters of illusion. They make things appear and disappear, with consummate ease. Copperfield made the Statue of Liberty disappear once before millions of live and television audiences. How he does it only he knows, but it is a feat not to be easily duplicated, maybe for a long time to come.
The financial markets have their own share of David Copperfields. They do not train at academies of magic like David went to anymore. More often than not, they will have Harvard or Wharton, rather than Hogwarts diplomas hanging from their walls. Today’s magicians wear pinstripes rather than coattails, weave magic with gold Mont Blancs instead of magic wands. Like true magicians, they have audiences breathless and spellbound, and their abilities at the smoke and mirrors game are no less stunning.
One big difference, though. In Las Vegas, the audiences are there for the magic show.
They know that the rabbit has not actually disappeared; it is still in the hat.
Or maybe not in the hat, but somewhere close by anyway. Animals do not really disappear. Nor do statues of liberty. They just appear to. That is the trick of the master illusionist. And he gets paid for it. Big time, as in the case of the David Copperfields.
On Wall Street, however, a different kind of magic goes on entirely.
Normally, it is the reverse illusion, with things appearing rather than disappearing. Billions of dollars of revenue seem to just materialize from nowhere, exciting the markets and making demigods out of the chief financial officers that made it happen.
But while the people in the seats in Vegas know that completely blinded by the magic tricks. They entrust the magicians with billions of dollars of their life’s savings, only to see a substantial amount of it disappear completely, unlike the rabbit that is still in the magician’s hat. Magic of the most deceitful kind. Something David Copperfield would never contemplate doing.
The magic word is not, as David would exclaim—”Abracadabra.” The new mantra is EBITDA, that harmless line at the bottom of the company’s profit and loss statement that proclaims to the world how much money it has made, before giving the banks and the government their share, and prior to allocating something to cover for the cost of their capital investments.
NOT SO SIMPLE. As we explained in our column last week, earnings should really be intuitively simple to measure. Simply the difference between how much you sell your products and services for, compared to what it cost you to acquire those products, and provide for those services.
The fish vendor knows the concept well. She buys fish from the market for P1,000, and sells it to her customers for P2,000. As far as she is concerned, her earnings for the day are P1,000. She sees the money actually going out of and coming into her pocket. No illusions are necessary. No tricks are required. Business is at its most transparent.
In today’s complicated organizations, measuring earnings is anything but a simple and intuitive process. The time difference between capital investments and their expected revenue streams are often far apart. Outlays for expenditure are many times intended to benefit future periods, and not always when they are paid for. And revenue streams do not often pay for products and services delivered or rendered in the current period—frequently they represent deliveries of goods or provision of services far off into the future.
Complexity like this makes earnings measurement difficult to understand.
Only the experts could navigate their way through the numbers. This environment provides fertile ground for the smoke and mirrors tricks that many companies today play.
Published in the Sun Star Daily, Saturday, August 10, 2002 (http://www.sunstar.com.ph/static/ceb/2002/08/10/bus/batuhan.smoke.and.mirrors.html).