That may be a funny question from a Chartered Financial Analyst, but financial statements often distort, rather than reveal, the nature of a company. Beyond outright fraud, where managers just make things up, there are lots of examples of accounting practices that are misleading, like marking everything to market. During the financial crisis, when companies got into trouble their debt was downgraded. Ironically, this created an earnings boost, because their debt suddenly got cheaper.
Financial statements are necessary to understanding a company’s economic reality. But they’re not enough. Most people know what McDonald’s sells, did you know that two-thirds of their sales come from outside the US? Because so many companies generate so much revenue from non-US sources it gets really complicated. Different legal standards, accounting issues, and tax laws make it hard for the most scrupulous manager to communicate what’s really happening. Add to this the misaligned incentives that corporations sometimes attach to their financial performance, and you have a recipe for trouble.
Just giving up isn’t an option, though. Financial statements need to be combined with other sources of information about a company. These include management’s discussion of their results, the quarterly conference calls that accompany earnings reports, especially the Q&A sessions, channel checks, and site visits to store locations, production facilities, and company headquarters.
Photo: Free-Photos. Source: Pixabay
In the end, all these inputs can help us learn more about any company: what they do and how things are going. Analysis is like putting together a jigsaw puzzle: every piece is important; taken together they have a story to tell. But if you just look at one measure or a small segment, you won’t see the full picture.
We don’t have to like our obscure accounting rules, but we do need to understand them.
Douglas R. Tengdin, CFA
Charter Trust Company
“The Best Trust Company in New England”