GE doesn't make money selling jet engines or power turbines.
Rather, it makes money selling long-term service contracts for jet engines and power turbines. These service contracts are extremely profitable, especially after the first decade. They are, however, extremely complicated to account for, and therefore susceptible to accounting frauds. There are many things that nearly destroyed GE—borrowing short and lending long, falsifying inventory values, writing poor long-term care insurance policies—but the accounting fraud with long-term service contracts was quite pernicious.
Rather, it makes money selling long-term service contracts for jet engines and power turbines. These service contracts are extremely profitable, especially after the first decade. They are, however, extremely complicated to account for, and therefore susceptible to accounting frauds. There are many things that nearly destroyed GE—borrowing short and lending long, falsifying inventory values, writing poor long-term care insurance policies—but the accounting fraud with long-term service contracts was quite pernicious.
Here's why.
GE made minor tweaks to service contracts—reducing the cost of parts, changing maintenance schedules—to immediately boost revenues, and consequently profits.
There was just one problem: while revenues increased on paper, no actual cash from customers came in the door. These revenues in excess of billings were recorded on the balance sheet as contract assets.
In 2000, contract assets were less than $2 billion. By 2017, they ballooned to nearly $30 billion. That's a lot of reported revenues that never came with cash from customers.
In 2000, contract assets were less than $2 billion. By 2017, they ballooned to nearly $30 billion. That's a lot of reported revenues that never came with cash from customers.
GE summed it up well in its 2017 10K:
Cash used for contract assets was $4.0 billion in 2017 compared with $3.9 billion in 2016. Cash used for contract assets in 2017 was primarily due to cumulative catch up adjustments driven by lower forecasted cost to complete the contracts as well as increased forecasted revenue on our long-term service agreements and the timing of revenue recognized relative to the timing of billings and collections on both our long-term service agreements and long-term equipment contracts.
To cover the short fall, GE sold assets—mostly receivables. GE management did this for years until there was nothing left to sell.
The jig was up. Investors, finally aware of GE's false accounting, dumped the stock. The stock, which traded over $160 in 2016, plummeted to the low $30s by the end of 2018 (adjusted for splits).
That's a long fall from grace.
The jig was up. Investors, finally aware of GE's false accounting, dumped the stock. The stock, which traded over $160 in 2016, plummeted to the low $30s by the end of 2018 (adjusted for splits).
That's a long fall from grace.
(I read many books about GE's rise and fall, but my favorite is Lights Out: Pride, Delusion, and the Fall of General Electric by Thomas Gryta and Ted Mann.)