Investors need to keep in mind that many companies often try to highlight their positive numbers rather than the loopholes involved in respective financial results. But those numbers could involve manipulating the figures, which might lead to fraud by misleading investors. Investors should be cautious enough when they read financial numbers. They should look for more information supporting these data facts. Accounting policies, management history, trend over previous years, economic indicators, macro facts should also be taken into accounts, while analyzing the results. Let us understand this from the following aspects:
GAAP Accounting: Public companies are required to follow generally accepted accounting principles or GAAP in reporting their financial statements. But those rules do not always put a company in best picture and therefore many companies opt for non-GAAP measures to report on their business. There is nothing wrong using these non GAAP measures which could also give investors greater insight into a company’s results by making adjustments that exclude certain amounts that may not be relevant to future operations. On the other hand, when company promotes its results by using non-GAAP measures, then any false figure can result in misleading investors and could give a rosy picture for company’s performance. Therefore, investors must analyze these numbers and must try to take review of numbers with regard to the GAAP accounting, which would reveal the real picture, and help investors in making a right decision.
Cash flow statement is important: Most of the time, investors consider only income statement and the balance sheet while neglecting cash flow statement. On the other hand, one should consider the cash flow statements as it contains critically important analytical data. It is important to note the distinction between being profitable against having positive cash flow transaction. A company bringing cash does not mean it is making profit and vice versa. It is not only the profit figure which matters but what is also important is that the cash is generated from operation and investing outflows. Cash flow statement also aids in understanding how company finances its need at working capital as well as long-term levels. Cash flow statement helps company analyze the actual funding position.
Financial ratios and indicators: Ratios transform the numbers into meaningful relationship to judge company’s financial performance and conditions. The resulting ratios must be viewed over extended period to reflect trends. One should be careful about one size-fits-all syndrome. Evaluation of financial metrics can differ significantly by industry, company size and stage of development. Therefore, the ratio must be analyzed, not just for the reporting year but they also need to see the historical data to find the trend and analyze sudden changes, while dig the fact for more information. Similarly, the same can be used to find trend for future estimates and any sudden change in ratios for future period should call for more explanation. Similarly, attractive returns ratio as compared with peers also help us to find more data for such variation before taking investment decision.
Change in accounting policies: Several times, companies change the accounting policies, like the rate of depreciation, or depreciation method. These inflate the profit numbers and inflate financial statements. Investors should be cautious about such change in accounting policies. The investors should carefully read the auditors’ report as well as notes to the accounts. The qualification made by the auditors should be read carefully. Similarly, thorough understanding of company’s notes is essential to read the financial statements in order to properly evaluate company’s financial condition and performance.
Forward looking statement: There are forward looking statements other than historical statements. Forward looking statements are provided to assist the reader in understanding the company’s financial position. These statements also include results of operations periods as well as comprise information about management’s current expectations and plans relating to the future. Readers are cautioned that such statements may not be appropriate for other purposes. Forward-looking statements include statements that are predictive in nature, while depend upon or refer to future events or conditions. Certain assumptions are made to draw conclusion or making forecast for future in forward-looking statements. These statements are subject to inherent risks and uncertainties that might give possibilities while the expectations might not prove to be accurate. Investors need to be cautious about such statements and look for more supporting data.
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