happyguy72
Two points.
First, if the financial statements for Spongetech complied with GAAP, the company would certainly have established a valuation allowance for bad debt (or bad receivables). There's no company in America that I know of that has a track record of collecting 100 cents on the dollar for money owed to them, with the possible exception of those owned by Tony Soprano and his associates.
And we all know that the longer receivables stay on the books, the less likely it is that they'll be collected on down the road.
If you look at America's best known and (generally acknowledged) best run companies -- companies like Johnson & Johnson, Proctor & Gamble, Wal Mart, etc., they're delighted to have 95%-plus collections on their Accounts Receivable. Most other companies aren't so lucky. Many, if not most of America's best run financial companies were, obviously, way off the mark with respect to their understanding of bad debt allowances for a huge variety of products they sold and serviced.
So the operative question is this: What portion of Spongetech's Accounts Receivable is uncollectible? Is it 10%, 20% or ... ?
If it's 10% then the company's most recently reported profit is overstated by about $620k (or 10% of the company's pre-tax net). If it's 20% then double that figure to about $1.2 M ... and so forth.
There are few guarantees in life, but I can guarantee you that Spongetech isn't going to collect all $14 M in receivalbes that showed up on its balance sheet as of Feb 28 2009. And I'd be willing to bet dollars to doughnuts that when the audit is completed the new accounting firm is going to require an allowance for doubtful accounts, which is a direct hit to net income.
Second, talk with your CPA friends about the most recent statement of cash flows from operations for the period ending Feb 28, 2009. Spongetech included $9.7 M of cash the company received for the sale of stock in that section of their cash flow statement. So their operating cash flows are overstated by what I'd consider to be a material amount -- by $9.7 M.
Back that out to get a rough proxy (but certainly a better measure than Net Income as reported) of the amount of cash the company took to the bank from its normal, ongoing, day-to-day business operations and you'll see the company would have reported ($9.9 M) in operating cash flows instead of the ($170k) they reported.
Like I said, this is a huge disparity and it's clearly not in compliance with GAAP standards, since the proceeds from the sale of the stock are a financing cash flow and belong in the section below.
So what, you say, cash in the bank is cash in the bank, whether it comes from selling sponges or from issuing stock, right?
No, not really. Spongetech is in the business of selling sponges, not stock. That's why you want to know how much cash the company is generating from its normal, ongoing, daily business activities. And that's why the $9.7 M belongs in a different section of the cash flow statement. It just helps you as an investor to understand how the company is faring as an ongoing economic entity.
And by the way, I think this particular misstatement was intentional, since one of the other companies that Moskowitz runs -- the little mom-and-pop modeling agency he runs that's also publicly-held -- actually got the cash flow stuff right in their most recent set of financial statements, though that's another discussion.
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