Concepts and Definitions
Back to Basics, Part 2

By Vince Hanks

We began last week a journey, not to faraway places, but instead to where we've already been. We're getting back to basics, and we'll continue this week by reviewing more concepts and definitions as we dig deep into the report cards of the American publicly traded company and begin to analyze the data within. This week we'll focus on a few accounting terms as they relate to financial disclosure.

Comparable Time Periods

In order to arrive at a meaningful conclusion, it's important to contrast like periods of time when investigating financial statements. This means comparing the fourth quarter of 1999 with the fourth quarter of 1998, or the first six months of 2000 with the first six months of 1999. Direction is the key here, rather than position. Did profits grow compared with the equivalent period a year ago? Did shares outstanding grow, shrink, or maintain? Did the company take on a boatload of debt compared to last year? It's also very useful to look at comparable periods going back several years to gain perspective.

Industry Benchmarks

Several industries will have unique gauges that aid in diagnosing a company's health compared to the same period last year. A typical example is same-store sales in the retail sector. This is the percentage increase in sales achieved by stores that have been open for at least one year. Become familiar with the industry benchmarks for the companies you wish to evaluate.

GAAP

What is GAAP? Hip clothing store with snappy TV ads? Close, but no Khaki. GAAP stands for Generally Accepted Accounting Principles, which is a set of rules for accounting that determines how financial information must be presented in financial statements. GAAP ensures that we're all speaking the same language when looking over the numbers.

Accrual Accounting

One of the main principles of GAAP is Accrual Accounting. Most businesses report earnings using the accrual principle of accounting. This means that sales revenues and related expenses are recorded when they are earned and incurred whether or not cash has been received or paid. Accrual-basis accounting includes credit sales in the revenue line on the income statement and records them as accounts receivable in the balance sheet. Similarly, both paid and unpaid expenses are recorded as expenses on the income statement. Accrual accounting results in the best measure of a firm's profitability and allows a fair comparison with previous periods.

Accrued Interest Expense

With accrual accounting comes Accrued Interest Expense. This is the amount of interest the company owes on its debt obligations as of the date of the report. Reflecting this interest expense allows a more accurate assessment of the company's current financial position.

Assets With Value

Assets With Value often make their way onto a balance sheet under accrual accounting. Assets with value that are expected to contribute to a company's future sales and income are recorded. If the asset's value is less than the amount recorded, the asset is "written down," which is sort of like being written up by your boss. Write-downs are when the company reduces the amount of an asset recorded on the balance sheet because the asset has decreased in value. A write-down is an expense item and will decrease the company's income for that period.

>> The Balance Sheet >>

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