Integrity and the cost of funds.

As a member of the United States Air Force Reserve and a bank examiner for the federal government, I enjoy the benefit of getting a big-picture point of view of two very different world--aerospace and banking. When I first read an article in USA Today titled, "Companies face credit crunch as investors fret," I was reminded of the importance of integrity and how it impacts on the cost of doing business.

Whether you work for the government or in the private sector, being able to make decisions based upon clear and accurate financial data is essential. We still see reports in the media about questionable accounting practices performed by various organizations that resulted in financial collapse. These practices prompt the public to ask questions, especially those of us in the financial management profession. Such questions may include, "How much debt or other liability does a company really have ?" and "How does this liability impact the company's financial or operational performance?"

Financial analysts reasonably have less certainty of where the company really stands when the volume of liabilities is undetermined. If corporate debt ratings are lowered because of this uncertainty, then the cost of borrowing increases, or the availability of credit may disappear altogether. The consequence on the company is diminished liquidity to operate, decreased earnings (due to higher interest expenses for investors), and less capital for business growth,

Whatever the reason or reasons that may cause problems with the integrity of accounting data (for example, error, competitive pressure, greed, or incompetence), we all directly or indirectly share the cost. This cost is reflected in lower levels of liquidity, earnings, and capital. In reference to liquidity, if short-term commercial paper is no longer available to fund daily operations, then a line of credit with a potentially higher cost may be needed.

Earnings are eroded by a higher level of interest expense as borrowing costs increase to service a debt that bears a lower credit rating. The payments for higher interest expense translate into lower earnings for the company and lower dividends to the investor. Capital, under increased pressure from a potential loss in earnings and diminished liquidity, may be less able to support ongoing operations. This results in an increased probability of bankruptcy.

All companies are subject to the perceptions of the financial markets and, indirectly, so are the company's investors, employees, and customers (which may include the government). Investors take the risk of gaining or losing their investment whenever they invest in a financial instrument. Some financial products obviously have more risk and return than others--for example, a savings account versus common stock ownership.

If the company's financial statements are inaccurate, however, the investor incurs a higher risk and a greater possibility of loss on investment. The employee of a company having financial problems suffers from the uncertainty of layoff, lower morale, and decreased productivity. The customer, be it an individual, another business, or the U.S. Air Force, may have to deal with both a less reliable product source and higher prices. And finally, as firms downsize or fail, the different levels of government suffer from lower tax revenues and additional unemployment compensation claims to laid-off workers.

The bottom line is that without integrity in accounting and financial management, we all pay more.

Reference

"Companies face credit crunch as investors fret," USA Today, February 22, 2002; Thor Valdmanis

Major Joseph M. Williams is the Chief of Acquisition Cost Estimating in the Space-Based Radar Joint Program Office at Los Angeles Air Force Base in El Segundo, California. Previously, he served as an Individual Mobilization Augmentee in the Space & Missile Systems Center Financial Management Acquisition Cost Division for four years before he volunteered to return to active duty in 2003. While in the U.S. Air Force Reserve, Major Williams also worked as an assistant bank examiner for the Federal Deposit Insurance Corporation, where he performed financial analyses on FDIC-insured banks.