When it comes to assessing the value of a company today, the financial statements clearly play an essential role. Without the financials, we simply would not even have a place to start.

Where do the numbers come from? The numbers in corporate financials result from corporations following a set of accounting rules known as generally accepted accounting principles (GAAP). By debiting and crediting numbers to various accounts, as directed by GAAP rules of accounting, the set of financial statements, namely the Balance Sheet, the Income Statement, and The Statement of Cash Flows can be assembled for use by the investment and lending community.

There’s an interesting thing about GAAP. Within GAAP, there are a multitude of different accounting valuation methods for virtually every account on the balance sheet (how the balance sheet is accounted for feeds into the numbers on the Income Statement and the Statement of Cash Flows). I’ll use the Inventory account to describe what I mean about GAAP leading to different sets of accounting numbers.

GAAP inventory valuation methods include first-in, first-out (FIFO), last-in, first-out (LIFO), Dollar value LIFO, Moving average method, and Weighted average method. The inventory amount on any given company balance sheet at a point in time will depend on which inventory valuation method is followed in accounting. The various methods basically impact the “timing” of when inventory gets written off to cost of good sold (COGS). Generally, across a wide enough span of years, it will all work out in the wash since we are talking about “when” we make our accounting adjustments.

What I just explained with regard to inventory about alternative (timing) accounting measurements under GAAP is true for most accounts on the balance sheet. This means two identical companies could reflect different accounting numbers at the same point in time due to the accounting method(s) selected under GAAP. The selection process gives corporate management a good bit of lee-way in managing the timing of accounting numbers ultimately portrayed to investors and creditors.

I don’t share this information to alarm, but rather to make aware, and further, to make a point. The financial statements exist so that investors and creditors can make better decisions. Yet the numbers are far from absolutely precise. The numbers can involve judgement on the part of corporate management and are impacted time-wise by the accounting method selected. The significant take-away (point) is to remember that when making an investment  decision toward a certain company stock, we use the numbers in a sound manner, understanding that all other market participants face the same thing when it comes to the imperfections in the accounting numbers related to the diversity of GAAP.

My balance sheet method to investing, shared in my book, Choose Stocks Wisely, reflects my personal effort to make use of the financials as intended. Knowing that accounting methods can be “managed” to some degree is a key reason why I seek a hefty equity value from the balance sheet behind the low price my method calculates. Avoiding risk and practicing conservatism with numbers goes hand in hand.

Over the many years I’ve taught accounting, I’ve always told my students that if I had my way, we would do away with all the alternative accounting treatments in GAAP and go with an agreed-upon best single method for every company to follow for the given account. My thought about simplifying the GAAP code is kind of akin to the notion of a flat-tax for all taxpayers. With regard to valuing stock investments, simplicity and consistent methodology behind the accounting numbers could only help.