Tuesday, July 01, 2003 :::
A friend recently remarked that, when he was young, he thought of public transportation as being expensive, because you had to pay $1.50 to ride the train while you could drive for free. I took this as an opportunity to launch into an explanation of the difference between earnings and cash flow of a corporation; basically, earnings accounts for the value of assets and liabilities, while cash flow doesn't. Earnings is clearly the more accurate of the two, except when it's not, e.g. when the people tallying the earnings don't wish it to be, i.e. are lying. Many investors today look at cash flow rather than earnings. (Even if management isn't lying, cash flow can be important if a lot of payments are coming due in the near future; unless you can borrow against your assets, they generally can't be used to make debt payments.)We have, as is often the case, a situation in which added flexibility can be used for good or evil, and design of government counsels toward inflexibility. Thus it's probably good, on the whole, that governments generally use something closer to cash flow accounting — in any case, meaningful requirements of balanced budgets will have to refer to cash flow — but it certainly leads to occasional unfortunate results.
My favorite is that of the Sioux City, IA, school district, which found itself strapped for cash for three decades, and responded by not building any new buildings, nor, in some cases, doing certain advisable maintenance. When the value of assets is allowed to decrease, cash flow looks better than earnings; they kept cash flow near zero while creating a growing invisible debt. The moral of the story has been taught over the past few years; we hope it has been learned.
The more recent story, though, is the many states, including Illinois, that are now experiencing crises. Illinois had a $5B (cash flow) deficit, and has successfully repaired it; $2B of the cash flow comes from the sale of buildings, many of which will have to be leased back by the state. Another $2B, incidentally, comes from a game that would not work in a straight cash flow system, and would not be out of place in corporate America: bonds will be issued to shore up the state pension funds, for which return assumptions are significantly higher than the interest rates on the bonds issued, so that the accounting value of the liability that the bonds represent is less than the money for which the bonds will be sold. (Cash flow accounting for a pension system couldn't even pretend to make sense, but the way accounting is done allows even more room for games there than in most other places in the budget.) As it has been reported in some outlets, the state of Illinois is borrowing money to play the stock market, and assuming it will come out ahead. How the next year's budget will be balanced should make a good show.
::: posted by dWj at 1:05 PM
