You can rely on audited financial statements. The risk of fraudulent financial statements is minimal, although recently there have been several high-profile cases in which large national and international CPA firms had to pay huge settlements to investors who relied on what turned out to be fraudulent financial statements. Overall, however, this risk is very small.
You might think twice before investing much time in analyzing the financial statements of corporations whose securities are publicly traded—because hundreds of other investors have done the same analysis and the chance of you finding out something that no one else has yet discovered is nil. On the other hand, for a quick benchmark test you might compare the percent change in the company's sale revenue over last year with the percent changes in its net income and operating assets. Major disparities are worth a look.
Reading financial statements is the best way of getting acquainted with the financial structure of a business that you're thinking of investing in. Don't worry too much about businesses that use conservative accounting methods. There seems to be no adverse effect on the market value of their stock shares. For privately owned companies, on the other hand, you should keep an eye on the major accounting policies of the business and how these accounting methods affect reported earnings and asset values.
Disclosure in financial statements leaves a lot to be desired. Don't look for a road map of the profit strategy of a business in its financial reports. Last, the total value of a business is not to be found in its balance sheet. Until an actual buyer of a business makes a serious offer there is no particular reason to determine the value of the business as a going concern. Value depends mainly on the past earnings record of the business as forecast into the future.
The main message of this final chapter is to be prudent and careful in making decisions based on financial statements. Many investors and managers don't seem to be fully aware of the limitations of financial statements. Used intelligently, financial reports are the indispensable starting point for investment and lending decisions. I hope my book helps you make better decisions. Good luck, and be careful out there.
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