Cash is a fact.

“Income is an opinion, cash is a fact” are some words of wisdom an accounting professor told me once. It’s true. The reason is that there are unbelievably crafty people out there who use and abuse accounting rules to finesse what gets counted as “income” for a company and how. But what no one can legally manipulate is how many dollars came in, and how many came out.

So regarding Microsoft’s goodwill impairment, Gruber says:

Six billion here, eight billion there, and pretty soon you’re talking about real money.

Well, that’s a matter of interpretation.

The income statement is, elementally:


I’m not trying to be offensive. I just think it’s important for what I’m getting at to use this framework. Revenues and expenses are the sales and costs associated with running the business. They directly relate to operations and are permanent, recurring costs. Gains and losses are transitory — usually write-downs, impairments, or charges related to restructuring. They are a dumping ground and it’s not always clear what belongs there. Companies in trouble can spend a lot of time either jamming gains into revenue or expenses into losses to make people think things are less permanently bad. But analysts get paid big money to be insightful enough to parse those numbers and read through the ruse companies often fabricate.

Goodwill, which is that Microsoft had 6.2-ish billion dollars more worth before this month, is a pure fiction. Seriously. It’s the excess purchase price over the value of the purchased assets. That’s it. Microsoft added up all the assets of aQuantive, and whatever was left over in the purchase price went into goodwill. Microsoft believed phasing aQuantive into its platform would yield benefits in the form of synergies and overall magical goodness that would make it 6 billion more valuable. This was a stupid decision, and it often is. Companies often wait for a good time to impair their goodwill because they often overpay.

What’s important is that nothing happened to Microsoft this month with respect to its finances.

Ok that’s not entirely true. But what happened was that Microsoft lifted $6.2 billion of goodwill from its balance sheet, where it sat as an asset, and funneled it through its income statement as a loss. Note: Microsoft paid for aQuantive years ago. The cash has long since left the firm. It’s just that part of it was capitalized on the balance sheet as an asset. The rules of accounting demand that we account for things as they are incurred. So the purchase of the original assets went right out of cash years ago. But as long as the goodwill isn’t used up, there it sits. If Microsoft didn’t think there was a material reason to impair it, it would sit there forever. Literally. Till the end of Microsoft’s days. Goodwill in a past time used to be amortized over a number of years. Not anymore. It’s a completely nonexistent asset. If you wanna know how bogus it is, Microsoft actually had MORE goodwill in June 2012 than a year earlier (13,452 million vs. 12,581 million). Not really because it created value. It just paid excess over the total asset value of its acquisitions.

Anyway, Microsoft funneled the aQuantive goodwill through its income statement, which impacts net income, which impacts retained earnings (earnings after dividends) which get added to the equity portion of the balance sheet and it all balances again. That’s the accounting that is required to get that goodwill off and have order restored.

If you wanna know what really happened to Microsoft this quarter you can look at its cash flow statement, which takes income and reconciles it with what actually constituted cold hard currency. There, Microsoft had $7,677 million in positive cash flow from operations. That’s for 3 months. Nearly $8 billion in 3 months. That’s an increase over a year ago.

You can say Microsoft is doomed long term because the server and tools division is making more in revenues than Windows (5,092 million vs. 4,145 million) — although on an operating income basis Windows is still more profitable. You can say these acquisitions are squandering cash on the purchase date and goodwill impairments show that wise management choices were not made back then. The internet services division will continue to be a drag on earnings (which lost about $400 million anyway this quarter before the goodwill impairment). That’s all fair. What you can’t do is jump on this announcement and say that we saw some kind of turning or inflection point for Microsoft this quarter. Because truly, it did a maneuver that involved shifting numbers around on some spreadsheets to appease US accounting standards.

If Microsoft is in decline, it’s because of secular trends in the mix of its operations and the reduced future operating cash flows that will stem from them. A lesser risk is continued bad acquisitions, which come out of investing cash flows (I say lesser risk because Microsoft could remedy bad acquiring by simply no longer acquiring. On the other hand, fixing a business model can be impossible if you’re hemorrhaging cash — see Nokia and RIM). Goodwill impairments will never, however, hail the end.


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