Though neither perfect nor exhaustive, the basic financial statements required of US public companies can go a long way toward providing investors with a reliable picture of a business’s financial standing.
These quarterly and annual filings mandated by the Securities and Exchange Commission contain a range of information about a company’s assets and liabilities (balance sheet), its earnings and expenditures (income statement), money coming in and going out (cash flow statement), and more.
In preparing these statements, US companies are required to follow the Generally Accepted Accounting Principles (GAAP) established by the Financial Accounting Standards Board (FASB), which has been recognized by the SEC as the authority on such matters.1 Financials also come with accompanying notes that can make them easier to understand and provide additional nuance, including disclosures related to accounting policies and practices, income taxes, retirement benefits programs and stock-based compensation.
While having a uniform accounting rulebook allows for apples-to-apples comparisons of companies, many companies have chafed at the prescriptive, rules-based nature of GAAP and have chosen to supplement the SEC-mandated principles with non-GAAP figures they believe more accurately represent their financial performance. In 2017, for example, 97% of the S&P 500 Index used at least one non-GAAP metric in their financial statements.2 While these figures can offer valuable insight for investors, their subjectiveness suggests they should be taken with a grain of salt.
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HBO prestige dramas aren’t generally a reliable source of financial insight, but a recent rewatch of a season six episode of The Sopranos revealed surprising—but wholly contextual, as it turns out—depth in the character of Pauly Walnuts. “Do you even know what your EBITDA is?” the silver-winged underboss of the DiMeo crime family asked the son of a dead associate in an effort to dissuade him from selling his father’s sanitation business. “Earnings before interest, taxes, depreciation and amortization. It gives a true picture of a company’s profitability.” While Pauly’s fiduciary commitment may have been lacking given his boss’s economic interest in said sanitation business, he wasn’t wrong in questioning the comprehensiveness of the son’s due diligence.
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