I've managed to pry my nose off the project management grindstone and rear my bloody face long enough to field a few reader questions this week. While I'm not back on a clockwork schedule, I'll be cropping up from time to time in this space like a stubborn case of foot fungus to provide the raw answers to your itching analytical queries. So keep sending those inquiries
here , and I'll do my best to help find you the answers you need. And now, on with the show. In TSC's tidbits on income statements and balance sheets, they keep saying "read the MD&A," but what is that? -- Katherine Margolis Katherine: Back in college, I would have said it stands for "Mad Dog & Absolut." (The Boilers are not known for their discriminating tastes when it comes to liquid refreshments.) The sober truth is that it stands for "Management Discussion and Analysis," or a largely redundant commentary that splatters a few pages of ordinarily succinct and elegant financial tables over 10 sheets of tedious prose. The idea is to give the quantitatively challenged a verbal play-by-play of the corporate figures, but the result is a kind of sick twist on the "picture's worth a thousand words" concept. While you can occasionally find some informational gold nuggets buried in the debris, it's mostly just worthless filler. Lately, I've thought that the average MD&A could make a valuable education for a third-grader. Check out these earth-shattering revelations from Anheuser-Busch's ( BUD) recent 10-Q as remedial coursework. Vocabulary -- Define "domestic": "Domestic volume represents Anheuser-Busch beer produced and shipped within the United States." Logic -- Give an example of circular reasoning: "The increase in marketing, distribution and administrative expenses in the first quarter 1999 compared to the prior year is due primarily to higher overall marketing spending and increased distribution costs." Business -- Explain how a beer brewer might show an increase in sales: "The increases in both gross and net sales were primarily due to higher domestic beer sales volume." Anyway, you get the idea. Like most corporate commentary, take the MD&A with a grain of salt (or in this case, with tongue in cheek). Given my limited resources, together with a need to diversify, I am limited to low-cost stocks, which in general do not seem to have much in the way of published financials. What they do have is usually not very long term, so trend analysis is impossible. Does this mean you would steer clear of small stocks? -- Jim Kendrigan Jim: If you want to gamble your apparently meager savings on a bunch of fly-by-night penny stocks, that's up to you. As far as I'm concerned, you can take your "limited resources" sob story back into the closet of psychological rationalizations where it belongs. A few years back in the heyday of full-service commissions and extra charges for odd-lot trades, your argument might have held water. These days, you can drop a trade for 10 shares of GE ( GE) at the same $9.95 or so that it costs to buy 1,000. So what if you can't buy a round lot of a household blue-chipper at $80 a pop? A 20% gain is still 20% no matter how many shares you own. In short, stick to the basics, buy good companies and if you can't afford round lots of 100 shares on eight to 10 companies, just buy fewer shares of each one to achieve the same level of diversification. In reviewing an annual report from Flexsteel Industries (FLXS), I noticed that depreciation listed as positive value in calculating operating income. How is the depreciation considered a positive asset? -- Lee Goad Lee: This single question may fully account for the prevalence of baldness among B-school accounting professors. Before I start yanking tufts from my scalp in exasperation, let's start with a quick review of depreciation. As you may recall from my previous series on the Basics of Fundamental Analysis , "accrual" accounting rules can seem counterintuitive to those of us used to balancing our checkbooks with a basic cash method. For example, when you write a check to buy a big-screen TV for say, $2,000, your personal net income falls for the year. Put another way, everything that's left over at the end of the year after you've earned all your money and paid all of your bills decreases by the amount of the purchase price. Not so for corporations. While that same big-screen TV costs the same $2,000 in cash for Flexsteel Industries, it doesn't impact net income until it's "used up" over the course of operations (presumably for screening forklift training videos). Instead, the company treats the TV purchase as a simple asset exchange: Two thousand dollars of cash is exchanged for a $2,000 television. From this perspective, the company is no better or no worse off than before the deal since the value of the firm's total assets remained the same. Assuming the TV has a useful life of five years, over the next 12 months, $400 of the TV asset will have invisibly been "consumed" by the company. This $400 is recorded as an expense in the form of depreciation, which impacts the firm's net income. The same $400 expense is recorded every year for five years, even though no additional cash ever changed hands. So when I'm accounting for changes in cash, I can't simply use net income as a proxy. I need to add back the "invisible" cost of depreciation that gets recorded as an expense unrelated to actual cash outlays. On the statement of cash flow, this shows up as a positive add-back. That's all for this week. See you next time, and remember to keep lobbing those questions from the outfield in here to home plate .