How to read annual reports 2

How to read annual reports 2

We are back to our topic here on annual reports. Basically, when you look at a company’s financial statements inside the annual report, sales revenues and profits going up are good signs, and naturally if they go down, that’s bad. But there’s more to it than just that, of course.

More tips and notes here from US investors on reading annual reports (these tips are actually valid all the time, and actually regardless of geographical location; I just got them from US sources):

Read the footnotes; read all the footnotes. The dirty secrets will at least be mentioned in the footnotes. There are many chances for companies to exercise sleight of hand. For instance, a company can extend the number of years of depreciation on major assets (lowering current expenses), hereby resulting in an increase in earnings. This sleight of hand would be revealed in the “summary of significant accounting policies”. Also, for instance, stock options can be expensive for shareholders (mainly through dilution of shares), and not reflected in the earnings. The company must disclose in a footnote what earnings would have been, if options had been factored into the net earnings calculation.

Many believe that the number one figure to look at is the company’s sales in the income statement. This is important. If sales aren’t going up, you need to find out why. If sales are rising, but profit isn’t going up proportionately, look out. The company may be slashing prices out of desperation. If, however, a company’s earnings instead are now going up faster than sales, it might be due to creative accounting. Now really look out!

Take a look at net income to total capital from the balance sheet, called return on capital or ROC. This here is a really good gauge of earnings stability, and would make you a really good fundamental analyst. Operating cash flow is generally considered to be profits before interest, taxes, depreciation, and amortization (such as writing off leased assets) and is called EBITDA. This might be important to you.

You can get a good feel for where the income for the company came from, and where it went, using the statement of cash flow. Not all earnings come from a company’s every day sales. This is key. This statement will show activities such as investments or sales of fixed assets such as a plant.

You can see many things from the balance sheet, for instance, debt is the money that a company owes for long-term financing, either from traditional lenders or from the sale of corporate bonds. Compare debt to total capital (equity). Too much debt is risky, since a slowdown in sales could threaten a company’s ability to pay its obligations. But here, most importantly, you must actually look further to see what the debt has been used for. If the money was used for earnings-producing plant and equipment – that is actually good and poses no reason for concern. If it was used for corporate perks – that is bad and is a red flag.

What are some other things to look for? You can try asking yourself questions about the annual report. For instance, let me cite some here. Is the report well written, clear, concise and succinct? Is it honest and forthright? Are photos inside the annual report modelled/simulated or live? How well do they relate to the text of the report? Do they present an accurate picture? How clear are the company’s product plans? And also, how does the company compare with others in same industry? What else do I need to know? What can I ask? Who do I contact from the company if I have further questions?

You can ask yourself many other similar and related questions. Always ask! Perhaps it is important to also discover more on the Internet regarding how to dissect and analyse annual reports further.

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.