Filtering Out Accounting Noise

by Investing School on July 13, 2011

If the term “accounting noise” is new to you, the phenomenon is not likely to be. When a firm is trying to make its financial situation look better, or worse, than it actually is, and it is bending or even breaking Generally Accepted Accounting Principles, it is engaged in accounting noise.

It is to be expected that most companies will “fudge” a bit when presenting the public picture of their financial situation, and that is exactly why investors should read such statements very carefully. This includes reading footnotes, financial statements and any other validating documents they can get their hands upon. This kind of behavior is questionable, but incidental.

Other firms may deliberately engage in a pattern of behavior and abuse that involves manipulating their earnings in order to look like they are in a good position, when they are not. This may also be called aggressive accounting.

For the investor who gets taken in by such a scam the cost can be significant. A company which is struggling might manipulate the appearance of its earnings, creating accounting noise to disguise the underlying problems. Investing in such a company is a very poor risk, but the noise may hide the truth.

The best way to avoid being taken in by accounting noise is to learn how to properly read financial statements and mine the correct information. Don’t be taken in by glowing reports issued by the company – do your research independent of anything offered by your potential investment. People might lie, but figures, and an understanding of what activities the company is involved in, rarely do.

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