The Interpretation of Financial Statements
Later editions revised with Charles McGolrick.
Summary
Graham and Meredith produced a short primer that walks line by line through the balance sheet and income account of an industrial company, defining each item in plain language before turning to ratios. It runs well under a hundred pages of text plus a glossary, and it was written for investors with no accounting training.
The method is definitional rather than analytical. The authors explain what cash, receivables, inventory, plant, goodwill, current liabilities, funded debt and surplus mean, then show how to compute current ratio, working capital, book value per share, margins, interest coverage and earnings per share. They repeatedly warn that stated asset values are historical costs rather than market values, that goodwill and intangibles deserve suspicion, and that a single year's earnings tells an investor little.
Its value today is as the shortest possible introduction to reading a company's accounts, and as a record of what Graham thought a non-professional needed to know. Buffett has recommended it for exactly that reason.
It is badly dated as a technical guide. It predates the statement of cash flows, modern lease accounting, deferred taxes as now presented, segment reporting, stock compensation and every rule an analyst now spends time on. Anyone using it should treat it as a conceptual starting point and read a current accounting text alongside it.
Key takeaways 7
- An investor can read a company's accounts usefully without formal accounting training.
- Balance sheet asset figures record historical cost and say nothing about what the assets would fetch.
- Goodwill and other intangible items on the balance sheet deserve to be treated as worth nothing until proven otherwise.
- Ratios matter only in comparison, either against the same company's past or against competitors.
- A single year's reported earnings is an unreliable guide to earning power, so average across several years.
- Current assets less current liabilities is the first measure of whether a business can survive a bad year.
- Fixed charges coverage matters more than reported profit for judging the safety of a bond or preferred issue.
Who should read it
Investors and operators who have never formally studied accounting and want the concepts in one short sitting before moving to a current textbook.
About Benjamin Graham
Co-founder, Graham-Newman Corporation; lecturer in finance, Columbia Business School 1928-1956
Security Analysis and The Intelligent Investor are the founding texts of value investing and remain the primary source every later value investor argues from.
Where it sits in the reference 2
Who recommended it 1 · 1 direct
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