Every company must publish an annual report to its shareholders as a matter of corporate law. The primary purpose of this report is to inform shareholders of the company's performance. As a legal requirement, the report usually contains a profit and loss account, a balance sheet, a cash-flow statement, a directors' report, and an auditors' report.
Many companies also provide a lot of other non-statutory information on their affairs, in the interests of general communication. In some cases, this may be little more than gloss, contrived to illustrate the company's wonderful achievement while remaining strangely silent on negative features.
What guarantee is there that an annual reprot is a true picture of a company's performance and not just propaganda put out by directors?
All annual reprots have to include a report from the auditors, independent accountants charged with investigating a company's financial affairs to ensure that the published figures give a true and fair view of performance. Their investigation cannot extend to examining every single transaction (impossible in a company of any size), so they use statistical sampling and other risk-based testing procedures to assess the quality of the company's systems as a basis for producing the annual report. They are not infallible, but they stand between the shareholders and the directors as a way of trying to ensure probity in the running of the company.
Understanding the main contents of an annual report.
Standard sections in annual reports can vary from country to country, but the following is the contents list of a medium-sized UK public company - let's call it X plc.
X world
Chairman's statement
Chief executive's view
Financial review
X in the community
Environment, health, and safety
Board of directors
Directors' report
Board reprot on remuneration
Director's responsibilities
Report of the auditors
Financial statements
Five-year record
Shareholder information.
Financial statements - are the main purpose of the annual report. In the example of X plc, these consist of:
- Consolidated profit and loss account. The profit and loss account of all the group as one.
- Consolidated and company balance sheets. The former is the group balance sheet and the latter shows the parent company alone.
- Consolidated cash-flow statement. A guide to how the money flowing in and out of the company was utilised.
- Notes to the accounts. These amplify numerous points contained in the figures and are usually critical for anyone wishing to study the accounts in detail.
Five-year record - shows a very abbreviated set of profit and loss and balance sheet figures for the current and previous four years. Some companies provide a ten-year record.
Choosing the right order in which to read the report
1. Start with the auditors' report.
Remember that this thin grey line of accountants is all that stands between the outside shareholder and the directors. To speed up matters, look at the final paragraph, their opinion. Does that statement give a true and fair view? If so, fine. If not, then it is said to be 'qualified'. Qualifications vary in depth from the disastrous, meaning that the company has got something seriously wrong, to perhaps a difference of opinion between the auditors and the board over some accounting matter. Most auditors' reports are unqualified, but, if there is a qualification present, you will have to judge how much the accounts can be relied upon as a measure of the company's performance.
2. Next, turn to the five/ten-year review
This is where you build up a mental picture of the company's financial history. Look at EPS - is it increasing, decreasing, fluctuating wildly? This gives you an idea of how it has been doing over the period. Look at dividend, if any, and consider their patern. Do they follow EPS or, as is likely, are they showing a smoother picture? Look at company debt, if the information is there, and compare it with shareholders' funds. How is it changing over the years?
Generally try to build up a view as to whether the company is doing better, worse, or perhaps has no particular pattern over the period. Depending on your reasons for reading the report, a set of prejudices will have begun to develop from this historical picture. If it shows a declining financial situation, this could be a good thing from some points of view - if you wish to acquire the company, for example. If you are an employee though, it would not be very encouraging. So, reading reports depends to some extent upon which angle you are coming from.
3. Now read the chairman's and directors' comments
These will give a deeper feel for the company's business, over and above the raw numerical data. Try to exercise a degree of scepticism in some areas, because it is natural for directors to attempt to play up the good points and play down the less good ones.
4. Get to the heart of the matter (the financial statements and the huge number of notes that accompany them)
The kernel of the report comprises the financial sttements and the huge number of notes that accompany them. A lot of it is in highly technical accounting terminology, but it gives you the intimate financial detail on the year. Never ignore the notes - they are critical. In fact some investment analysis read the report from the back, because the notes are so important.
Notes have increased dramatically over the years as new legal and accounting standards have been introduced, primarily to enforce standardisation so that accounts are more comparable, but also to avoid 'creative accounting', whereby some companies have tried to conceal (legitimately) financial undesirables.
5. Relax with the glossy stuff
Having absorbed all that really matters, settle back and read the glossy bits that tell you how wonderful the company is. Just remember to exercise a mild degree of cynicism here - this is the least important, though no doubt the most visually attractive, part of the annual reprot. The real picture of the company is the numbers, not the photo of the bloke in the hard hat standing on an oil rig!
COMMON MISTAKES
Paying too much attention to pretty pictures and directors' comments and too little to the accounting data.
This can give a false view of how well, or badly, the company is doing. Understandably, a large number of people have difficulty in comprehending the figures. But if you want to appreciate annual reports properly, then learning to read accounts is essential.
Some cynics among investment analysts have even expressed the view that there is an adverse relationship between the number of glossy pages in an annual report and the company's actual performance. Maybe that's a little harsh but ... there might be something in it.
Also read:
No comments:
Post a Comment