Trade The Journey

Trade The Journey

Small Accounting Tip!

Reading accounting statements can be a confusing process and if you are not aware of some of the nuances involved in reading these statements, you can arrive at an a incorrect evaluation.  Currently, I am listening to a book by Mary Buffet entitled, “Warren Buffet and the Interpretation of Financial Statements” where she shares what she has learned from Warren Buffet in regards to reading financial statements.

It is quite a interesting book where it covers the income statement, balance sheet statement and cash flow statement almost line by line. Warren mentions that if you do not want to invest the effort in learning how to read financial statements then you probably should not invest. Reading financial statements entails a fair amount of visualization and analysis to come to a conclusion about a company. What Warren Buffett is looking for is a competitive advantage. A sure thing.

I thought there were no sure things when investing?  As I continue to listen to the book, hopefully I’ll be able to surmise how Warren Buffett is able to identify a sure thing or as close to a sure thing as possible.

The book offers small tips like comparing the income tax to the amount stated in the net income adjusting for any one time entries such as non-reoccurring events sometimes listed to boost earnings. The income tax was 35% but with the new tax laws they have been decreased to 21%. So the income tax should be 21% of the net income if the net income listed is correct. I highly recommend you read this book after you have read a couple of accounting books to gain a grasp of some of the terms and concepts. Most of finance and investing is understanding the terms.

There are two factors you should be aware of when looking at financial statements for your review:

                                                                        Timing and Classification

When does the company recognize revenue? Is the revenue or sale recognized before the actual product or service is delivered or completed, for example?

When does the company recognize expenses? There are many ways to delay or front load expenses.

Are the Assets overvalued? There are many ways to recognize asset value, for instance you can recognize the asset at the “market value” which is based on assets in the current market and what they are selling for. Or it could be held on the books at the original purchase price which may be lower than the market value. You could see a jump in net income if the company held the asset at historical cost and proceeded to sell it a higher market price.

Undervaluing Liabilities. There are a number of ways to alter the liabilities account so that expenses may not show up until the next period or perhaps they move the liability  to a different account. Always read the financial footnotes. Some of the discrepancies in the numbers may be explained there.

There’s a little more to investing than meets the eye. This is just one aspect of evaluation that we all should be aware of. Please be sure to share any corrections or some of your tricks of the trade when attempting to make an accurate evaluation using financial statments.

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