Tackling Financial Statements

So I’m still on the quest to deciphering financial statements. And I still think that a sports analogy will help me draw a parallel between the two so I can be a more informed investor.

I’ve been asking around different forums and groups of people with more experience than myself, and one of the suggestions was something I kind of feared but never really looked into.

Brip Blap’s advice:

” . . . start by learning accounting . . . In other words, I’m not trying to discourage you, but REALLY understanding financial statements is an exceptionally complex science. There are thousands and thousands of rules that even gearheads in my line of work struggle to understand. I would not look for one book to be able to give you anything more than a very, very vague introduction. Grab a used accounting textbook and understand first how debits and credits work, even before you study GAAP. Take a course if you have the time or inclination!”

I feared as much, and after reading that and thinking about it for a few days, I wasn’t sure what I was going to do. Part of me knew that he was right, and part of me was lazy: I don’t want to be studying up on no accounting.

So I’m sitting at work, thinking about when I’ll get my formal offer for my next job, when it hits me: Brip Blap is right. Not because he’s got a blog I enjoy reading and he knows way more than I do on the subject of financial statements (both true statements), but because I understand what he’s saying.

Before I can “read” a financial statement and try to extract some kind of meaning from it, I need to know how those numbers got on there in the first place. How they were recorded, by whom, and what subjective decisions (if any) go into creating these numbers.

A subjective decision in a financial statements? Sound confusing? It was to me too—until I tried to put in into the context of sports and the financial statement of the game of baseball: the box score.

Is there anything subjective going on in a box score? Well, think about the error statistic. Someone who doesn’t know too much about baseball can look at that number in isolation and deduce, “Oh, this guy isn’t very good. Look at all those errors.”

Is that a correct statement? It might me. But you would need to look at several things: what position he plays (shortstops make more errors than other positions because they have more balls hit to them) and what his fielding percentage is (which takes into account how many balls are hit his way).

Is that enough? Not quite.

Say a fast player hits a weak ground ball between the third baseman and the shortstop (SS). The SS charges hard and tries to barehand the ball and throws on the run and the ball happens to go wide of the bag. The runner is safe at first.

Is that an error? We can’t say for sure because it’s up to the official scorer. Sometimes it may be called one and sometimes it won’t: it’s a subjective decision.

These kinds of insights aren’t available to someone who doesn’t understand the intricacies of the game.

In other words, financial statements are to accounting as the box score is to baseball.

Do they give you a good idea of what’s going on? Sure. Is it everything you need to make an informed decision? Not even close.

So now that I understand what Brip Blap is saying, I know what I need to do: learn more about accounting. So far I’ve checked out two books: Accounting for Non-Accountants and How to Read a Financial Report. Anyone out there have any experience with these books? Any other books that might be helpful?

I’m a book guy so my first move is get a book about what I’m trying to do, though I know a course will probably be more helpful. My new job may help me out with this (in terms of tuition reimbursement), so hopefully that can happen. Until then, it’s going be all about reading.