Financials, also known as the financial statements, are critical to managing a business successfully. We know the four standard financial statement are the 1) Balance Sheet, 2) Profit & Loss/Income Statement, 3) Cash Flow Statement, and 4) Statement of Retained Earnings.
To run a business, these provide the most basic required financial information on which to build your business metrics. We understand that the first two of these financial states focus upon the company's earnings (or losses) and how the results are related to the overall value of the firm. The last two financial statement focus more on cash. How it is moving through the business and what is done with the cash not used to operate the company.
Simple enough, but understanding that what is included in the various calculations and how they effect the financial statements cannot be left to a surface examination.
A quick example of a line item that can easily mislead one doing a quick analysis of a firms financials is the calculation of Cost of Sales (COS). The COS often is a consolidation of results for multiple smaller companies or units within a larger company.
Plus, how the COS are combined and calculated is not left to chance.
An important example of a line item that can easily deceive someone doing a surface analysis of a company's financials is the calculation of their Cost of Sales (COS). The COS often is a consolidation of the results for multiple smaller companies or units within the reporting firm.
Plus, how the cost of sales are put together and calculated is not left to chance. The COS and other key reporting details are worked through carefully to:
protect a company's proprietary sales and expense information and
provide some significant wiggle room when it comes to providing information to investors and competitors.
(For a good recent example, look at how Apple is using this technique to mask what many believe are less than stellar early sales of their watch and falling iPad sales.)
Stories like this are intriguing, but what they are doing is perfectly legitimate and the reported financial results of these companies will still adhere to the technical guidance from FASBAB and the commonly agreed upon accounting principals (GAAP).
Another area where the interpretation of the "Cost of Sales" line item can vary significantly occurs with:
online marketing firms and
companies paying significant sales commissions.
We won't dig into that this week, but for public companies you are investing in, working for, or considering working for take the time to read their recent 10-Q filings. If you work for a private company, carefully look at the numbers you are provided internally and look for comparable firms in the public market that could help you understand how well the company is doing, where there is internal waste, or where to invest dollars to help support growth.
"If isolation tempers the strong, it is the stumbling-block of the uncertain." - Paul Cezanne