How to read annual reports 1

How to read annual reports

There are many ways to read an annual report. How you actually read an annual report depends upon your purpose or goals. As an investor, your purpose may be to assess: profitability, survivability, growth, stability, dividends, problems, risks and other factors which may affect your investment in that particular company. Again, you come to read an annual report with your goals in mind.

Also, read annual reports often. Reviewing a company yearly is the minimum diligence required. The annual report provides a convenient way to do fundamental analysis of a company’s fundamentals. If you own shares in a company you should receive a copy in the mail that will come right here to your doorstep. Sometimes you can even get them online nowadays.

Annual reports are a corporate "work of art" and are not read like a normal book. It is actually a kind of "never ending story" as the entity progresses along, merges, closes or is acquired. A company’s financial statements inside the annual report will actually tell you what a company has (its assets), what it owes (its liabilities), its sales (revenue), and how much it made in the accounting period being reported (its profit or net earnings).

There are normally nine identifiable sections in most annual reports. Not all reports will have all the sections, or the same type of information. Here is an introduction. Here are the usual, basic sections and what to look for in each of them:

Chairman of the Board Letter
This should cover changing conditions, goals to achieve or have been achieved or missed, actions taken or not to be taken, and stuff like that. Is it well-written? What does it actually say and what does it actually mean? Reading between the lines is important here - what is being apologized for? Anything to worry about?

Sales and Marketing
This should cover what the company sells, how, where and when. Is it clear where the company makes most of its money presently? Is it understandable? Is the scope of product lines, divisions and operations clear?

Summary of Financial Figures
Is this included? How many years are presented (2 or 4 or 5 or 10)? What's the growth of profits and operating income?

Management Discussion/Analysis
Is there a clear discussion here of significant financial trends over, say, the past two years? How candid, forthright, clear and how accurate is it?

Opinion Letter by Auditor
This here is written by an accounting firm as an opinion on the company's financials. The important thing to look for here is what the qualifications are. What do they say?

Financial Statements (important!)
Check sales, profits, R&D spending, inventory and debt levels over time. This is really important. Read the footnotes to ferret out other information. Look around this website for more valuable tips on how to do that.

Subsidiaries, Brands, and the like
Where is the headquarters? Is it clear what lines, brand names the company has and what the overseas distribution network is?

List of Directors
This one is always present in every annual report. How many outside directors and how many inside directors? Are the directors well known and respected? Are there less than 5 or more than 12 directors?

Stock Price History
This one is not always present, and may not be of great importance. General trend of price over time: up or down? Which exchange is company traded/listed? Stock symbol? Bonus/dividend history?


In addition, according to my research, there are 3 statements that the SEC in the US requires corporations to file on a quarterly basis:

Balance Sheet
Income Statement
Statement of Cash Flow

The Balance Sheet is divided into:
Assets
Liabilities
Capitalization/ Net Worth (assets less liabilities)

The Income Statement is divided into:
Income (sales/revenue)
Cost of goods sold (producing inventory)
Gross profit (earnings before expenses)
Reserve for taxes
Expenses (overheads)
Net profit/earnings after all expenses

The Cash Flow Statement is divided into:
Adjustments to income
Changes in assets and liabilities
Financing activities such as sale of stock or bonds
Cash flow from non-operating activities
Net change in cash and cash equivalents

… more to come here in the following blog post on this website.