US Government Teaches Financial Statements
Did you know the US Government teaches financial statements? Now, before you get too excited, the information given on the governments website is basic. But, it's certainly enough to gain an understanding of the subject.
Part of our taxpayer money is used to maintain the Securities and Exchange Commission SEC. This is the government body that is responsible for making sure public companies play by the rules. It's not a perfect system and the agency doesn't have enough resources to keep tabs on everything businesses do. But, it helps to keep most legitimate businesses on the level.
Aside from its role of keeping businesses honest, the agency also publishes a good amount of information about the investing arena. One such publication is a Beginners' Guide to Financial Statement.
What I like about this quick resource is it explains that reading a financial statement is about more than crunching the numbers. While important, an equally important aspect of businesses is the qualitative information. These include the Management Discussion & Analysis (MD&A) and the Footnotes. Both of these sections are ignored by most investors. Yet, they continue crucial information that can help you with your investing decisions.
The biggest problems with these sections is they seem cryptic at first. But, you'll see that when you take the time to read them, they are more readable than most people give credit for them. It's a matter of getting used to the verbiage.
Each CEO will have his or her own style in writing about the company, which you'll see that writing in the MD&A. Combing through several MD&A sections will reveal that they share common traits from one to the next.
The training comes from the Securities and Exchange Commission (SEC).
Perhaps the biggest takeaway of this training is learning about the accounting equation. You may remember that equation from your accounting class in school. It is a fundamental aspect of accounting, which makes it essential to include in the government article.
You can read about it in the report (link above), but here is the concept to help remember:
Assets = Liabilities + Equity
You'll see this equation shown a bit differently on the report. It shows it as follows:
Assets = Liabilities + Equity
Why the difference? When you read the training, you'll learn that assets of a company can be financed by two primary methods. The first is the money that is contributed by the owners of the business. This is called equity.
Conversely, when business owners seek capital in the form of loans, this is called liabilities. The lenders often obtain a claim on the business until the amount loaned is paid back.
The concept is somewhat similar to buying a home. When you purchase a home, you seek out a mortgage (unless you have enough to pay the house in full). The lender will require you put up a fraction of the equity in the form of a down payment. Then, you'll receive the remainder of the balance as a loan.
Note: people often confuse a mortgage and a loan for the house. The loan is the amount your receive, while the mortage is an agreement that the bank will take ownership of the asset (house) in the event of default and foreclosure. In essence, the loan and the mortage are tied together, which is why people associate a mortgage with the loan.
Other Resources to Help Learn
Accounting is a complicated subject. You probably pulled your hair out while taking the course in college. Unless you are an accountant or use accounting in some way in your job, you likely have forgotten most of what you learned.
But, as mentioned, grasping the basics is important for investors to understand the actions of the prospective (or even currently owned) businesses. The following are resources to help you in your learning of investing and accounting principles.
Accounting Coach is a great resource to help you understand accounting principles. Many of the modules are free and these free modules are enough for you to understand what you need to know. Of course, if you have an interest of learning accounting in more detail, feel free to upgrade. The cost of the course is quite cheap.
Investopedia has become a go-to resource for investors and it should come as no surprise that they cover financial statements on their website. What I like about the website in general, is that lately they include videos that help to further your knowledge on many of the topics. These videos are short and easy-to-consume.
What I like about this article is it has links that describe two important financial statements. It also describes how to construct ratios and how to detect when companies are playing tricks with their accounting numbers. When you learn this, you can avoid companies that participate in these financial games. The article should have covered cash flow statements, but you can find that information elsewhere (included the resources on this page).
This article is a bit dated as it describes Walmart from 2010. However, it shows an examples of what the statements look like within the body of the text. That's convenient for learning. It describes the process along with the example to aid in the learning process.
Reading the numbers from a financial statement can give you good insight. However, transforming those numbers into ratios is where you can take your analysis to the next level. This article describes common ratios and their meaning.
Another government resources that explains the basics of several investment options. This is not extensive coverage of the topics, but a great place to get started.