Book Review: How To Read A Financial Report By John A. Tracy

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Book How To Read A Financial Report

I took a break from my series of book reviews on the financial crisis to review a book on an unrelated topic (My next book review will be back to the financial crisis). My latest book review is How to Read a Financial Report: Wringing Vital Signs Out of the Numbers
by John Tracy. The book was brought to my attention after a leading value investor (I do not recall which one) recommended it as a great book on analyzing financial statements. I also researched the book a little and found many positive comments about it.

The author Dr. John Tracy wrote this book several years ago, but updated it in 2009 to reflect changes in current accounting law. John Tracy has authored many other books on accounting. Dr. John Tracy is currently retired; he is a CPA and was a professor of accounting for many years.

Overall, I thought the book was definitely a valuable read. I majored in accounting in a University where graduates have the highest CPA pass rate in the country (not to brag) I took many courses in accounting. I frankly found most of the information I learned to be completely useless. What is great about John Tracy’s book is despite the book not being too lengthy he can teach you more about balance sheets than you will learn by taken many account courses. You can learn a lot more useful information about balance sheets by reading John Tracy’s book than by reading several lengthy accounting text books.

John Tracy discusses at length the connection between the balance sheet and the income statement. He believes many accountants do not appreciate the connection between the two. He devotes a large segment of the book to the relationship between operating expenses and accounts payable, inventory and accounts payable, cost of good sold and inventory and other interconnections between the two financial reports.

Dr. Tracy devotes a short segment of the book to managerial accounting, I especially enjoyed this segment. Although, as Dr Tracy himself notes he could write a separate book regarding managerial accounting alone, in the few pages he writes about managerial account he provides readers some valuable insights. He asks what is better a 5% sales increase or a 5% price increase. In the fictional company used by Dr. Tracy a 5% price increases profit before fixed expenses by 22.3% whereas a 5% sales would increase the number by only 5%. This is because there are variable expenses that rise with increases in sales volume i.e. sales commission, cost of goods sold. Many managers will focus on increasing sales just to gain market share even if it would be more profitable to simply raise prices. However, Dr. Tracy notes that customers do not like price increases so a business must weigh its strategy carefully.

He also shows that even a small decrease in sales prices can wipe out all of a company’s profits, whereas a very large decrease in sales volume would be needed to bring a company into the red. This would explain why a deflationary recession is far worse than a recession caused by a decrease in business volume, yet which is not deflationary.

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My next book review will be Mr. Market Miscalculates: The Bubble Years and Beyond by James Grant. Following that I will be reviewing On the Brink: Inside the Race to Stop the Collapse of the Global Financial System by former Treasury Secretary Henry Paulson. I am very interested to hear Hank Paulson’s account of the financial crisis. The book was just released on February 1 and is already #10 best seller.

Disclosure: New FTC guidelines just released in December 2009 require me to disclose I have a material connection because I received a free copy of the book to review.

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