Reading financial statements – clarity at last (and just in time for the holidays)!

CPA Canada has recently published Reading Financial Statements – What do I need to know? Common Questions Answered, available for free, written by Alex Fisher and myself (but if you’ve had your fill of me from this blog, then just forget the latter bit and go on the assumption Alex wrote the whole thing!) This is from the publication’s preface:

  • “CPA Canada has developed this publication to help explain some of the fundamental concepts, conventions and principles underlying financial statements, which may be of interest to readers. This publication aims to answer some key questions a novice user trying to obtain a basic understanding of financial statements might ask.
  • This publication is intended primarily to assist readers in:
  • –   taking initial steps toward obtaining a greater understanding of what financial statements do, and what they do not
  • –   having better-informed conversations with financial advisors or others.
  • Even for those with no desire to obtain an in-depth understanding of accounting, we believe there is value in understanding some key accounting terms, concepts and principles, thus making this aspect of business and commerce somewhat less mysterious. However, out of necessity, this publication simplifies many matters that could easily be addressed at much greater length and in much greater detail and does not attempt to provide a complete understanding of the matters it addresses.
  • This publication does not attempt to provide a guide to identifying “good” versus “bad” financial statements or “healthy” versus “unhealthy” companies. Such evaluations depend heavily on the facts of a specific situation; an indication that’s troubling in one set of circumstances may be encouraging in another. For example, a current-year loss in a key business segment may in itself appear to be a negative sign; however, if the loss in the previous year was significantly greater, then the current loss may represent major progress toward becoming profitable. Also, a recorded profit may seem positive in itself, but a company that reports a profit may still be experiencing major challenges, such as escalating liabilities or deteriorating cash flow, (i.e., everything depends on the overall context). It is almost always unwise to focus on a single aspect of financial statements — whether apparently good or bad — without considering how it relates to all other information provided in the statements.
  • This Guide is not intended in any way to be a direct aid to making investing decisions. Even if a particular company could be objectively identified as a “good” company (e.g., indicated by generating consistent profit and cash on an ongoing basis), it does not follow that the securities of that company constitute a good investment. For example, the company’s stock may already be “priced for perfection,” thus limiting its potential for further gains. Because financial statements are often issued several months after the reporting date, the picture shown in those statements may have been radically changed, for better or worse, by subsequent events or changes in the market….”

We set out the publication in the form of thirty questions: some of them going to concepts and practices (e.g. “Are financial statements precise?”), some to structure and organization (e.g. “Why do similar companies use such different labels, captions and formats when they prepare their statements?”) and some to specifics (e.g. “What are impairment losses?”). Obviously, thirty is a somewhat arbitrary round number, and the material could have been continued almost indefinitely (and who knows, maybe it will be at some stage).

If you’re reading this blog, then you’re probably familiar with most or all of what’s in the publication – although even then, it might sometimes be refreshing to pull back a bit and spend a little time considering, at a very basic level, why in financial reporting we actually do this or don’t do that. I think the material should be relatively most useful to readers who are well motivated to understand financial statements to a certain point (general business students, say) but will never need to become experts. Most intriguing though, to me at least, is what life it might develop among a broader audience.

As the preface observes, there’s surely some value in being somewhat informed about financial reporting just for its own sake, just as it’s better to have some knowledge of history and physics and geography (although, in this great age of dumbing down, it sometimes seems that aspiring to anything other than happy ignorance is widely regarded as inherently suspect). But I can’t help noting that CPA magazine devoted most of its November issue to the subject of financial literacy, without ever mentioning (unless I overlooked it) this particular aspect of the subject, focusing more instead on day to day matters of household finance and suchlike. That’s understandable of course: to craft a vague analogy, if you’re going to set out to educate yourself about English literature, you’re not going to start off with Saul Bellow. But at the same time, if the profession itself doesn’t argue for the broad relevance and value of its prime product, who else will? Anyway, that’s a bigger project than our little publication can carry out by itself, but I hope it’ll seem like a credible contribution to it…

The opinions expressed are solely those of the author

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