Venture capitalists, private equity and family office investment professionals, as well as individual investors, all benefit from a variety of valuable skills in considering potential investments. Among them are intuition, interpersonal skills, sector knowledge, fundamental analysis and interplay within the capital structure. One discipline, frequently dismissed or overlooked by investors when receiving their formal education, is accounting. I believe, without a thorough understanding of accounting, other skills of the professional investor may be subject to discount.
The simple truth is this: building a disciplined and successful investment strategy is highly unlikely without a strong financial foundation. A background in accounting, whether by formal education or through operating/investing experience, can go a long way in that regard.
Successful investing requires, among other things, identifying skilled and experienced management, portfolio diversification, risk assessment and mitigation, being open and receptive to ideas of management and others, and being a supportive and contributing partner. Accountants, like professional VC and PE investors, spend significant time poring over and analyzing financial statements. Understanding the fundamental principles of accounting, therefore, could be quite helpful for professional investors when managing and growing their portfolios.
Two primary reasons why professional investors should hone their accounting skills are:
Development of an Intuitive Understanding of Financial Statements
When making investment decisions, having more than a fleeting understanding of accounting principles is of utmost importance. If a startup sells a product, what are their gross margins? What is their burn rate? How much of their income converts to cash to support further development, capital expenditures and, ultimately, debt service? Can the management team execute on the strategic plan if they don’t hit their (or your adjusted) numbers? There are as many of these questions/concerns as there are investors. Many of the questions during the analysis and due diligence process lead back to “the numbers.” Professional investors regularly wade into financial details to determine if a company’s strategic plan is viable, and to ascertain whether or not a company can achieve significant cash flow at scale. This analysis must be done in conjunction with, but ultimately independent of, management’s numbers. As such, professional investors must have the ability to understand, analyze, and be critical of, potential investee company financial statements.
Identifying Trends and Warning Signs in Your Portfolio
A successful investor should have the ability to identify patterns as they emerge. A practical understanding of accounting, and keeping a sharp eye on current financial results, enables professional investors to determine if management is executing per plan. Understanding accounting principles and financial results, provides investors with the requisite confidence to approach management and, if necessary, challenge them regarding operating results. Having this ability to identify patterns will not only endear you to management, you will also be an integral member of the team helping to build value for all company stakeholders. And, after all, isn’t that why we invest?
Admittedly, my educational and professional background may render me biased, however, I’ve concluded that a keen understanding of accounting principles is an essential component for successful investing. You can count on it!