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Salesforce’s Accounting Questioned

September 11, 2012 is receiving some stinging criticism for its accounting by bloggers on financial sites like Seeking Alpha and The Motley Fool.

The questions involve the accounting for stock option compensation. Salesforce is apparently figuring that since it is saving itself some cash upfront by compensating employees in part through stock options on top of their regular salaries, it can claim the cash it saves as part of its cash flow. It is then treating the saved cash as profits in the non-GAAP earnings it reports to investors.

Eventually, of course, the cloud-based customer relationship management software developer will need to pay for the stock options when its employees exercise them. In the meantime the stock options dilute the stock holdings of the company’s own investors. In addition, since this type of accounting treatment—in which costs are counted as profits—is not in accordance with GAAP, the losses under GAAP will keep mounting, even while the company appears to be beating analyst expectations on non-GAAP earnings.

“It's a Ponzi scheme that works as long as the stock price goes up, because if it goes down, employees will not accept stock based compensation as salary, which also means the company can no longer add this expense to its artificial cash flow,” writes Seeking Alpha blogger Wim Dankbaar.

I’m not sure I would go as far as calling it a Ponzi scheme, but it certainly indicates that Salesforce investors would be well advised to pay more attention to the GAAP numbers than to the non-GAAP figures. The situation is reminiscent of the kinds of pro forma earnings that were so popular during the 90s dot-com boom, until the bubble burst in 2000.

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