Calculation of profitability: The devil is in the details. Can 0.05% create an unacceptably high error margin?

Can a 0.05% have a material impact in an “Investment Plan Evaluation” scenario”? Almost all seasoned veterans will probably call it “peanuts”, categorize it as something that is “below materiality limit”, and not worth pursuing. Read on, because the answer will probably surprise and shock you, as much as it did me.

I used to strongly believe in the old saying, that in Financial Analysis, the person that thoroughly examines the nickels and the dimes, will probably let the 100 dollar bills pass in front of him without realizing what has happened. Or, in other words, if you spend too much time worrying about the small inconsequential values, you will probably forget to examine the large and most important ones. Actually, I still do believe in that saying.

The Greek Tax law 128/75 states that, on every last day of a calendar month, every Bank account gets examined. If the balance is positive (i.e. a deposit from the company to the Bank) nothing happens. If the balance is negative (i.e. a loan from the Bank to the company), then a Tax contribution is being collected. Its sum, is the balance of the Bank account on the month’s last calendar day, multiplied by 0.05%

I have yet to see anyone in commerce or industry, to include the Tax contribution of Law 128/75 in an “Investment Plan Evaluation” or an “Annual Budget” scenario. I imagine that it is conceivable that some people who work in the Banking sector might have done it, but I cannot be absolutely sure about that.

Recently, I conducted an “Investment Plan Evaluation” analysis, in a major Greek company, thru C2BII. In it, I decided to include the calculation for Law 128/75. In case you are wondering why I did it, my answer is: “because I could do it, and because I could be so accurate, with so little effort”. I fully expected that the company’s CFO would eventually make some comment about why I took the time to do it. I even had prepared an answer that went along the lines that, in C2BII, we have a system where the 100% accurate calculation is the fast and easy thing to do, while an approximation is more difficult and more time consuming to implement.

After I performed the profitability calculation, I started auditing the individual result numbers in order to see if anything looked out of place. When I first saw the calculated number for the Tax contribution of Law 128/75 my first reaction was to think that I had made a set-up mistake somewhere, because the number was way too large. Actually, the set-up and the calculated number were both correct. I tried to find a rational explanation for the size of the number that I was looking at. Then, it hit me. If you take a very big number and multiply it with an extremely small percentage, the result might not be spectacular, but it will definitely be “above materiality limit”.

To better understand this, let us assume that there is a Bank loan of 10,000,000€ involved, and that we examine the proposed investment on a 5 year basis. If you do the math, you will see that the total amount of the Law 128/75 Tax contribution comes to 300,000€. This is an expense figure that is way “above materiality limit”, and you definitely must not omit such expenses from your profitability calculation.

But wait. It can get worse.

Let us assume that the proposed investment’s profit, was calculated to be either a pessimistic 2,000,000€ or an optimistic 5,000,000€. Failing to register the 300,000€ expense from Law 128/75, results in an error margin that’s respectively 15% and 6%. I cannot find words to express how frustrating I find the fact that such a huge and unacceptable error margin can be created by such an insignificant percentage.

There’s no denying the old saying that “The devil is in the details”. The “little harmless looking things” that escape your notice, will eventually destroy your work. How many other “little harmless looking things”, like the Tax contribution of Law 128/75, are waiting around the corner? I really cannot answer that one for sure. Is there a method to protect ourselves and our work from such “Black Swans”? Without any hesitation, my answer is a loud YES.

In C2BII, we have the ability to create an accurate and controlled environment. You set up the way that every incident works, and then you let the system create a simulation of the Accounting books, or in other words, the only absolutely and undeniably accurate way to calculate “Profit & Loss”. It is like in experimental physics or experimental chemistry, where you insert the cause (example: “ingredient A” and “ingredient B”) in the controlled environment, and you wait to see the result that will come out. And if you expected the result to be a yellow liquid, but in reality you get a green gas, you start to reexamine your assumptions, in order to see what you have thought wrong. That is a (more or less) accurate analogy, to my discovery of the impact that was created by Law 128/75.

Stick around, as we are going to see how the “average Joe off the street” will evaluate an “Investment Plan”, and why that method is better than anything you can currently find in the Academic books.

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