Back to Basics, Part 2
We began last week a journey, not to faraway
places, but instead to where we've already been. We're getting back
to basics, and we'll continue this week by reviewing more concepts and
definitions as we dig deep into the report cards of the American publicly
traded company and begin to analyze the data within. This week we'll
focus on a few accounting terms as they relate to financial disclosure.
Comparable Time Periods
In order to arrive at a meaningful conclusion, it's important to contrast
like periods of time when investigating financial statements. This means
comparing the fourth quarter of 1999 with the fourth quarter of 1998,
or the first six months of 2000 with the first six months of 1999. Direction
is the key here, rather than position. Did profits grow compared with
the equivalent period a year ago? Did shares outstanding grow, shrink,
or maintain? Did the company take on a boatload of debt compared to
last year? It's also very useful to look at comparable periods going
back several years to gain perspective.
Several industries will have unique gauges that aid in diagnosing a
company's health compared to the same period last year. A typical example
is same-store sales in the retail sector. This is the percentage increase
in sales achieved by stores that have been open for at least one year.
Become familiar with the industry benchmarks for the companies you wish
What is GAAP? Hip clothing store with snappy TV ads? Close, but no
Khaki. GAAP stands for Generally Accepted Accounting Principles, which
is a set of rules for accounting that determines how financial information
must be presented in financial statements. GAAP ensures that we're all
speaking the same language when looking over the numbers.
One of the main principles of GAAP is Accrual Accounting. Most businesses
report earnings using the accrual principle of accounting. This means
that sales revenues and related expenses are recorded when they are
earned and incurred whether or not cash has been received or paid. Accrual-basis
accounting includes credit sales in the revenue line on the income statement
and records them as accounts receivable in the balance sheet. Similarly,
both paid and unpaid expenses are recorded as expenses on the income
statement. Accrual accounting results in the best measure of a firm's
profitability and allows a fair comparison with previous periods.
Accrued Interest Expense
With accrual accounting comes Accrued Interest Expense. This is the
amount of interest the company owes on its debt obligations as of the
date of the report. Reflecting this interest expense allows a more accurate
assessment of the company's current financial position.
Assets With Value
Assets With Value often make their way onto a balance sheet under accrual
accounting. Assets with value that are expected to contribute to a company's
future sales and income are recorded. If the asset's value is less than
the amount recorded, the asset is "written down," which is
sort of like being written up by your boss. Write-downs are when the
company reduces the amount of an asset recorded on the balance sheet
because the asset has decreased in value. A write-down is an expense
item and will decrease the company's income for that period.
>> The Balance Sheet >>