Identifying ‘Fake’ Account on Financial Statements

If you buy 100,000 shares of a stock at a price of Rp100 per share, worth a total of Rp10 million, and the next day your shares rose 2% to Rp102 per share, then what is your gain? Of course 2% multiplied by 10 million, yes? And the result is Rp200,000. The next question, would you surely get the cash of Rp200,000? No. The figure can still change at any time, along with the changes in the stock price. If tomorrow your stock climb higher to 104, for example, then your profit would be Rp400,000. Conversely, if your stock dropped to 99, then your profits will instantly disappear and turned into a loss of Rp100,000.

So, as long as you do not sell your shares, then your gain or loss is not yet fixed or real. If you sell your stock at a price of Rp102 per share, then your profit of Rp200,000 becomes real. So if there are people who sell their shares at a higher price than the purchase price, it is also known as realizing the gains. Similarly, if there are people who sell their shares at a price lower than the purchase price, it is referred to as the realization of losses. You have not actually receive the gain or loss, as long as your money is not yet in the form of cash.

Okay, but you are clearly know about that. So what exactly we are going to discuss in this article?

When you read a company’s financial statements, especially in the income statement, ever finding accounts like these? 'Unrealized gains', ‘currency loss’, or the like? Those aren’t real accounts, because there were no money that coming in or out. The accounts are usually placed under the account of operating profit. Although not real, these accounts often made a company's net profit soars, or otherwise, dropped into negative (loss). Here's an example, click image to enlarge.

The above is a page of financial statement of Citra Marga Nusaphala Persada (CMNP) for the period of first half of 2010. Take a look at the marked section: There is mentioned that CMNP received income outside of the company's operations, amounting to Rp236 billion, which is derived from unrealized gains from the decrease/increase in fair value of its bank loans and bonds. Thanks to this income, CMNP net income became more Rp400 billion, or soared 1,190.5% over the first half of 2009, which was only Rp31 billion. Wow!

But you have to realize that the figure of Rp236 billion is not real, because it could change at any time, along with the change of the fair value of CMNP bank loans and bonds. If the fair value is down, for example, then the profits will go down, or even being negative to reduce company’s net income. Conversely, if the fair value increases, the unrealized gains will also rise. The figure of Rp236 billion is derived from the fair value as at June 30, 2010, or at the date of the financial report. Today, that number might been changed.

Then when CMNP will take profit from its bank loans and bonds? When the company had paid off the debts, or sell it to another party. Just like you will receive fixed gain from your stock when you’ve sold it at a higher price than the purchase price.

So eventhough CMNP had revenue of Rp236 billion in its financial statements, but in fact the company did not received any money.

Because the figure is not real, aka not (yet) exist, then CMNP net profit of Rp400 billion is also not real. And that means? Company’s net profit increase of 1,190.5% was also not real! So you have to be careful every time you read a company’s financial statement, where you must check the accounts, one by one.

Another example is Mitra Adiperkasa (MAPI), which in 2008 had a Rp331 billion loss due to losses in foreign exchange. Because of this loss, MAPI net profit for the period became negative aka loss amounting to Rp70 billion, while its operating profit reached Rp303 billion.

Although there was no word ‘unrealized’ or such like the example of CMNP earlier, but the losses aren’t real, because it is not derived from increased costs, impairment of assets, or the like, but from changes in the exchange rate of Rupiah against Baht (Thailand). You see, one of MAPI subsidiaries namely TS Lifestyle Ltd., which is the owner of a fashion store in Thailand, presents its value of assets in the currency of Thailand, which is Baht. Most likely during the period of January - December 2008, the value of Baht against Rupiah dropped drastically, which may be due to the global crisis that occurred at the time, so that when the assets of TS Lifestyle are expressed in Rupiah (because MAPI’ financial statements are expressed in Rupiah), the value became dropped.

Here’s the illustration. Say the value of assets of TS Lifestyle in 2007 was 10 million Baht. Because at the time, the exchange rate of Rupiah against Baht was (for example, for illustrative purposes only) Rp350 per Baht, then the value of assets assets was equal to 350 x 10 million = Rp3.5 billion. In 2008, TS Lifestyle’ assets actually rose to 15 million Baht. But since the value of Baht against Rupiah dropped to Rp150 per Baht, then the value became 150 x 15 million = Rp2.25 billion, down by Rp1.25 billion compared to the period of 2007. In MAPI’ financial statements, the reduction was accounted as losses.

Then why you said that the loss is not real? Because it’s clear that the company did not lose any money. Once again, the numbers are only in the books alone.

If you notice, most accounts of income on financial statement that placed after operating profit, except taxes and interest on loans that have been paid, are not real. But some of these accounts are real. Some of accounts like dividend from an associated company, it was a real income, because the company are actually received money.

If you're not sure about these ‘unreal’ things, then you better avoid the stocks with that kind of financial statements. But typically, investors are less concerned about this. If a company scored a significant increase in net income, although the increase is unreal, the shares are still hunted. When this article was written, CMNP is in 1,330, aka rose more than 60% in the last year. The question is, what will happen if in later financial statements, the ‘fake’ gain is dissapeared?

Original article was written at December 28, 2010