Most investors are happily oblivious of accounting rules. I envy them.
Accounting rules are supposed to standardize how companies report their financial condition. Instead, the rules tend to muddy the waters.
Few realize that accounting rules are set by an accounting body called the Financial Accounting Standards Board (FASB). Although this body is supposed to be independent, when majority rule or special interests don’t like its rules, the Congress or Executive branch pressure it to toe the line. This is seldom in the interests of individuals or shareholders.
Accounting rules don’t stop shareholders from digging through the data and seeing things clearly. In fact, I’d say such an effort is one of the keys that allows dedicated investors to get better returns than most.
You see, what matters is not the accounting number a company reports, but how much money a business actually makes. What matters is cash: how much cash did the company make after all expenses.
Earnings per share and net income–the accounting fictions companies report–are not the same as cash. Accounting fictions are based on assumptions that can distort or even mislead. Cash doesn’t mislead. It’s what’s left in the the bank account at the end of the day.
Most investors ignore cash because it takes effort to calculate and understand. The accountants don’t make it easy to find. But, it’s there for those who look.
A business spends cash to buy inventory, pay workers, build factories. After it sells its end product, it receives cash from buyers. Subtract cash received from cash spent, and you have cash earned.
What matters it not accounting profits–which can’t pay dividends, repay debt, buy back stock, expand the business–but cash.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.