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Sunday, May, 2, 2010

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GAAP-prescribed disclosures and explications that impact the company's financial condition, but cannot be reflected by mere numbers. Found at the end of a company's consolidated financial statement.

So, you've read a company's balance sheet, its income statement and its statement of cash flow. You see the bottom line numbers, and, if you're like most people, you scratch your head and say to yourself, "Those are interesting numbers; I can see this company makes money, but I still have no idea how they do it or even what they do." Enter the notes to the consolidated financial statements. This is where the actual disclosure of a company's function and condition is accomplished. They are more than mere footnotes because, within them, you will find (to a varying degree, depending how complex a company's structure and business are) information that will allow you to put the financial statement into the context of a going concern. You can find GAAP on notes to the financial statement at FASB ASC Topic 235.

Notes will allow you to assess the entity's current financial position — is it really as good as those financial statement numbers indicate, or is something lurking that makes the company a real dog? As such, the notes assist in determining the bases the entity uses to calculate its financial results (i.e. its accounting methodology); obtain insight into its future prospects; compare itself to its competition; and get a bird's-eye view of how management sees the business.

To those ends, the notes can include any or all of the following, along with any other information, positive and negative, a company believes is explicatory of its financial condition:

Company summary: short history and description of its business
Summary of its accounting policies
Information on acquisitions of other businesses or disposals of any of its own assets
Dispositions or status of financial instruments, the change in values of which are reflected on the financial statements
Restructuring charges
Debt and borrowing arrangements (this could take many forms — credit facilities, warrants issued in company stock in exchange for cash, etc. These help you get a feel for a company's cost of borrowing and its ability to obtain additional financing)
Pension and retirement benefits
Explanation of stockholder equity, including options commitments and contingencies
Pending legal proceedings, including expenses
Segment data (this is provided by companies made up of many product lines that generate separate financial information; it allows the reader to distinguish between a company's more and less successful lines)
Subsequent events (these are events that occur after the date of the balance sheet that would otherwise have impacted the balance sheet)

Don't let the brevity of the above, non-exhaustive list fool you. Notes to the financial statements can be short-story length. For instance, Wal-Mart's 2009 Annual Report includes 18 pages of notes. So, in a real sense, it is the notes that are the meat on the skeleton of the financial statement. Unlike the financial statements themselves, there is no GAAP-prescribed format for the notes, so once the meat goes on the skeleton, you might find out the company is a bull instead of a bear, or a Wal-Mart instead of a Fred's Convenience Store.

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