Accounting gets so little respect in this world that when I searched for an uplifting quotation to start this column off, all I found was the negative one above. Sigh.
It's easy for us Fools to look to great investors such as Warren Buffett or Peter Lynch or Anne Scheiber (scroll down for her story) as our heroes. But, we'd be remiss if we ignored the world of accountants, for it's only through their work that we investors have much of a chance of building any wealth.
Investing is all about evaluating companies according to whatever metrics you use, and deciding which firms are most worthy of your hard-earned dinero. Some investors use Rule Breaker criteria, others use Rule Maker criteria. Many people use other systems and may do even better than Rule Breakers or Rule Makers. That's fine. Regardless, though, just about any approach relies on numbers in financial statements that are organized and presented according to the rules of accounting.
Consider our friends, the Rule Breaker criteria:
- The top dog and first-mover in an important, emerging industry.
- Sustainable advantage gained through business momentum, patents, visionary leadership, and/or inept competition.
- Excellent past share appreciation, measured by a relative strength of 90 or higher.
- Good management and smart backing.
- The greater the consumer brand, the better.
- A significant constituent of the financial media is recently on record for calling it overvalued.
If you're a Rule Breaker investor, you can get by without a super-deep familiarity with all the nuances of financial accounting. But, remember that Rule Breaker investing is the riskiest of our approaches and probably shouldn't be the only approach you use, if you use it at all (it's not right for every temperament). And, most other approaches require you to know your way around a balance sheet and income statement, at least a little.
So... if you've been meaning to learn more about how to read financial statements, here are some resources for you:
- Rule Maker Portfolio reports: The Rule Maker approach is much more number-intensive than the Rule Breaker approach. Many of these reports focus on company financials. Read them regularly and some useful stuff will sink in.
- The How to Read Financial Statements discussion board.
- The Motley Fool Investment Workbook, offering a simple introduction to financial statements.
- How to Read a Financial Report: Wringing Vital Signs Out of the Numbers by John A. Tracy, which takes you further into financial statements.
- Analysis of Financial Statements by Leopold A. Bernstein and John J. Wild; another book, best suited for serious students.
The most celebrated early accounting expert is probably the Franciscan friar, Luca Pacioli, who was a buddy of Leonardo Da Vinci. He's known as the father of double-entry bookkeeping, a method still pretty much in use today, 500 years after he wrote about it. (He credited a fellow Italian, Benedetto Cotrugli, with coming up with the essence of the system a few decades earlier.) Pacioli recommended that businesses regularly take inventory of all their assets and debt, and record them at current market rates. He even listed cash first, where it remains on today's balance sheet.
But, accounting was around even before the friar's days. According to Professor Linda Plunkett of the College of Charleston, it's actually the world's oldest profession! This makes sense because, even in prehistoric times, people had to keep track of things. And, as trade developed, the need for a system of currency arose, and along with it the need to account for costs and payments.
We have evidence of accounting activities in Mesopotamia around 3,500 B.C., and in ancient Egypt, China, Greece, and Rome, as well. Greece's contribution to the progress of accounting was major: coined money. Before this, people walked around with pockets full of chickens, corn, and animal pelts. (Well, not exactly, but close.)
If you find yourself interested in learning more about the history of accounting, go for it -- I provide some links at the bottom of this article. For some people, it's not easy to swing directly into deciphering financial statements, so it might help to ease into the subject of accounting via its history.
Accounting is a vital topic to master if you want to maximize your investing savvy. It's not easy and not always fun (until you get the hang of it), but you'll eventually understand how various entries are interrelated and what the rules are that public companies must play by. Get to that point and you'll find yourself glancing at financial statements and seeing all sorts of interesting things pop up. It's not unlike like the Rosetta Stone for a certain breed of investor.
How adept are you at reading financial statements, and are you interested in learning more?
- Not adept at all and not interested in learning.
- Not adept at all but I'd like to learn more about it.
- Somewhat adept and that's enough for me.
- Somewhat adept and I'd like to learn more.
- Fairly adept, thank you very much.