Anyone who aspires to become a serious investor must be versed in the language of accounting. Fluency in accounting is a necessary prerequisite to understanding a company's financial position. Without accounting knowledge, an investor can still get by, but risks making valuation errors that can result in serious mistakes. Even something that appears as simple as a company's current cash balance, which is found on the first line of the balance sheet of most companies, is not always as it seems. As an example, consider KSW Inc, a stock that has been previously discussed as a potential value investment.
Understanding the true picture of a company's cash position is not limited to reading the first line item of the company's balance sheet. This is because the company may actually have shared cash accounts that are not included in this number. We've already recently seen a couple of cases here and here where companies own significant equity in valuable companies. Because of the system employed to account for this ownership (the Equity Method), the carrying value of these interests can far understate the market value of such interests.
In KSW's case, the company lists a cash position of about $17 million (including "marketable securities"). But hidden from the balance sheet is the fact that the company actually has a 50% interest in a joint venture (accounted for using the Equity Method) which has $4.6 million in cash. KSW's share of this balance represents almost 10% of the company's entire market cap!
Of course, there are likely to be liabilities associated with this joint venture company. But according to the company's notes to its financial statements, the company expects to receive significant earnings from this JV, and has already received a few hundred thousand dollars worth of cash from it already. Furthermore, to ensure that the JV has enough capital, KSW and its partner have been billing the JV only for the costs of services provided; therefore, future profits and their associated cash flows are likely to come.
Most market participants care not for a company's cash balance; instead, they are focused on the company's earnings level one or two quarters out. But investors who view stocks as if they are claims of ownership in a private business understand the importance of a company's existing cash balance. Cash can stabilize the business through rough times, help the business invest in its future, or even be paid out to shareholders. As such, an understanding of a company's true cash position is necessary and important for the value investor.
Disclosure: Author has a long position in shares of KSW