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Importance of Accounting for Investors

The importance of accounting for investors is huge! Accounting is the language of business. That is what management uses to ‘communicate’ performance to the outside world. However management often wants to communicate only favorable news and this communication is often ‘mis’ communication.

Accounting for investors: Even if we assume that managements dont intentionally ‘mis’-communicate results, understanding accounting is critical for investors as it help explain whats going on inside a company.

A classic example from the last few days have been the huge story that Apple’s (AAPL) gross margin has declined in the fourth quarter ending on September 2010. Investors worried as Apple’s management said on the quarterly earnings call that the decline was due to the higher cost structure of their new products the iPad and iPhone and because of the exceptional value it is passing on to customers.

Turley Muller has a different take! He attributed the lower gross margin due to increased warranty provisions.

Apple’s warranty accruals had been averaging around 1% of revenue for the first three quarters of FY10, or roughly ~$150M. In Q4, warranty accruals ballooned to $457M, or 2.3% of revenue.

 

Turley’s point is that if warranty accruals have not increased, than AAPLs gross margin will bounce back. Whether this is true is a separate question. But this important observation required accounting for investors. This was an observation that saw through the management’s intentional or unintentional silence on this significant cost item.

Read Turley’s blog for interesting stuff like this.

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