A Blueprint for Digital Companies’ Financial Reporting (Harvard Business Review)

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Digital Companies Profit Differently. Should it be Reflected in Their Financial Statements?

A recent HBR article proposes a new blueprint for financial reporting when it comes to digital companies. Digital companies, like Facebook and Uber, function differently than their more traditional counterparts. This may not be accurately reflected by the current generally accepted accounting principles (GAAP).

The proponents of this blueprint suggest that factors driving revenue are often more relevant to investors than the actual revenue figures themselves. The authors referenced Facebook daily as an example of this. This asset doesn’t create revenue directly, however it draws advertisers who do.

New reporting methods would more clearly define these assets by delineating a company’s operating activities from its revenue-generating activities to draw linkages and identify value-producing trends for investors. This translation is the first component of the new reporting model.

Second, HBR recommends providing a statement of outlays, or total costs associated with a project or acquiring an asset. GAAP standards dictate that managers report soft outlays (i.e. new customer acquisitions or other non-physical assets) as operating expenses, while hard outlays (hardware, physical assets) are reported as capital expenditures. Newer reports should focus less on distinguishing between hard and soft outlays. Rather, they should separate maintenance expenses from investment figures to allow investors to decide what defines an investment or an operating cost relative to future profitability.

Additionally, current reports lack clarity in describing future projects. This could be improved in statements by:

  • Detailing project progress
  • Connecting the projects with current operations
  • Offering prospective launch dates

Finally, HBR recommends including one-time, special, and extraordinary items in financial statements. These are currently not required and companies remove these occurrences from their profit reports. Once again, this information could be valuable to investors.

This new blueprint will enable investors to see how a company values its assets and what the profit implications are, which provides a more accurate representation how profitable the company really is and, perhaps more importantly, how profitable it might become.

 

Read the full article “A Blueprint for Digital Companies’ Financial Reporting” here.