Chapter 1 - You Can't Always Trust the Numbers Flashcards
Summarize the chapter “You Can’t Always Trust the Numbers”
The key message of this chapter is that financial statements are not purely objective. They rely on assumptions, estimates, and judgment calls, and can be manipulated through both fraudulent and legal means. Understanding these factors is crucial for making informed decisions in a business context
What is the art of accounting and finance?
the art of using limited data to come as close as possible to an accurate description of how well a company is performing. Accounting and finance are not reality, they are a reflection of reality, and the accuracy of that reflection depends on the ability of accountants and finance professionals to make reasonable assumptions and to calculate reasonable estimates.
What is bias in terms of finance?
Bias means only that the numbers might be skewed in one direction or another, depending on the background or experience of the people who compiled and interpreted them. It means only that accountants and finance professionals have used certain assumptions and estimates rather than others when they put their reports together.
Income Statement
The income statement shows revenues, expenses, and profit for a period of time, such as a month, quarter, or year. It’s also called a profit and loss statement, P&L, statement of earnings, or statement of operations. Sometimes the word consolidated is thrown in front of those phrases, but it’s still just an income statement. The bottom line of the income statement is net profit, also known as net income or net earnings.
Berman, Karen; Knight, Joe. Financial Intelligence, Revised Edition: A Manager’s Guide to Knowing What the Numbers Really Mean (p. 6). Harvard Business Review Press. Kindle Edition.
Operating Expense
Operating expenses are the costs required to keep the business going from day to day. They include salaries, benefits, and insurance costs, among a host of other items. Operating expenses are listed on the income statement and are subtracted from revenue to determine profit.
Berman, Karen; Knight, Joe. Financial Intelligence, Revised Edition: A Manager’s Guide to Knowing What the Numbers Really Mean (p. 7). Harvard Business Review Press. Kindle Edition.
Capital Expenditure
A capital expenditure is the purchase of an item that’s considered a long-term investment, such as computer systems and equipment. Most companies follow the rule that any purchase over a certain dollar amount counts as a capital expenditure, while anything less is an operating expense. Operating expenses show up on the income statement, and thus reduce profit. Capital expenditures show up on the balance sheet; only the depreciation of a piece of capital equipment appears on the income statement. More on this in chapters 5 and 11.
Berman, Karen; Knight, Joe. Financial Intelligence, Revised Edition: A Manager’s Guide to Knowing What the Numbers Really Mean (p. 9). Harvard Business Review Press. Kindle Edition.
