Investing basics: Key constituents of an annual report

An annual report is probably among the most viewed company publications. It is the most comprehensive means of communication between a company and its shareholders. It is a report that each company must provide to each of its shareholder at the end of the financial year. To put it differently, it is a report that each shareholder must read.

But what is its use if one does not understand or refer to it?


As a shareholder of a company, you need to know its performance over the past financial year and the management's view on the same. You also need to know what is the company's future plan and strategies. As a shareholder, you need to know what does the management intends to do to attain those targets.

We present to you a brief on what the key constituents of an annual report are.

Key constituents of an Annual Report

Director's report: The director's report comprises the events that take place in the reporting period. This includes a summary of financials, analysis of operational performance, details of new ventures and business, performance of subsidiaries, details of change in share capital, and details of dividends. In short, shareholders can get a gist of the fiscal year from this section.

Management discussion and analysis (MD&A): More often than not, the MD&A starts off with the management giving its view on the economy. It is then followed by a perspective on the sector in which the company is present. Any major changes like inflation, government policies, competition, tax structures, amongst others are highlighted and discussed in this report. It also includes the business strategy the management intends to follow. Details regarding different segments are provided in this section. The company also gives a brief SWOT (strength, weakness, opportunity, and threat) analysis and business outlook for the coming fiscal.

This can aid the shareholder to understand what major changes are likely to affect the company going forward. However, as mentioned earlier, an investor should not blindly believe what the management has to say. While it tends to paint a rosy picture, one needs to judge the sanity behind the rationale.

Report on corporate governance: The report on corporate governance covers all aspects that are essential to the shareholder of a company and are not part of the daily operations of the company. It includes details regarding the directors and management of a company. These include details such as their background and their remuneration. This report also provides data regarding board meetings - how many directors attended the how many meetings. It also provides general shareholder information such as correspondence details, details of annual general meetings, dividend payment details, stock performance, details of registrar and transfer agents and the shareholding pattern.

Financial statements and schedules: Finally, we arrive at the crux of the annual report, the financial statements. Financial statements, as you are aware, provide details regarding the operational performance of a company during the reporting period. In addition, it also depicts the financial strength of a company. The key constituents of the financial statement include the profit and loss account, the balance sheet, the cash flow statement and the schedules.



This article is authored by Equitymaster.com, India’s leading independent equity research initiative

https://premium.thehindubusinessline.com/portfolio/beyond-stocks/investing-basics-key-constituents-of-an-annual-report/article23153778.ece

Reading the content of the Annual Report

The content of the Annual Report and Accounts is governed by the law and accounting standards, though directors do still have some discretion.

Listed companies are required to use international accounting standards.

If you are looking at the Report and Accounts of a listed company you will see the following:

• Independent Auditor's Report
• Balance Sheet (it might be called Statement of Financial Position)
• Statement of Comprehensive Income or it might be called Income Statement (this corresponds with the Profit and Loss Account)
• Statement of Changes in Equity
• Statement of Cash Flows
• Notes to the financial statements
• Chairman's Statement
• Directors' Report
• Business Review
• Directors' Remuneration Report

There is so much detail that there is really no substitute for diving in and having a look at the Report and Accounts of your chosen company.

Try not to get bogged down.  Best of luck.



Additional Notes:

Can you locate the following in the Report and Accounts of the company you are interested?

• the pre-tax profit (Profit and Loss Account)
• details of the fixed assets (Balance Sheet and supporting notes)
• the amount of any exports (the notes)
• is it an unqualified audit report? (the Audit Report)
• details of any political or charitable donation (the Directors' Report)
• was there a cash outflow in the period? (the Cash Flow Statement)
• details of the share capital (Balance Sheet and supporting notes)
• the amount of the capital employed (the Balance Sheet).

Reading an annual report of a company a day is probably the best use of your time allocated for investing.

It only takes about 2 minutes to know if a person is well versed with equity investing.  The majority are not and they should rightly invest through funds run by good professional managers.  They should know the limitations and costs of investing in mutual funds too.

For the few who are knowledgeable and comfortable to invest safely on their own, how can the time they allocate for their investing be optimally utilized?  

Probably, an hour a day set aside to read the annual report of a company of your interest is the answer, for me.  These annual reports are easily available through the internet.   Through discipline and hard work, you can then develop a good knowledge on these companies and their related industries.  

Over time, you will have deep understanding of many companies.  These companies that are within your circle of competence are monitored to benefit your investing.  

Buffett: 'Business is coming back' (How to write an Annual Report)

@25 min: How to write an annual report.

Warren Buffett's favourite pastime

One evening, Buffett and his wife Susan had dinner with friends.  Their hosts had just come back from Egypt.

After dinner, as their friends were setting up the slide projector to show him and Susan their pictures of the Pyramids, Buffett announced:

"I have a better idea.  Why don't you show the slides to Susie and I'll go into your bedroom and read an annual report."

Warren Buffett doesn't just enjoy reading annual reports.  It's his favourite pastime.  

"He just had a hobby that made him money.  That was relaxation to him."

A master investor lives and breathes investing 24 hours a day.

Warren Buffett's favourite book.

It should be no surprise to learn that Warren Buffett's favourite book on his favourite pastime is reading annual reports.

Shareholders' group calls for company reports to be made shorter

Shareholders' group calls for company reports to be made shorter
The length of companies' annual reports should be be made far shorter and their structure fundamentally changed, according to the Association of Investment Companies (AIC).

FTSE 350 companies' annual reports and accounts average 135 pages, the AIC says. Photo: AFP

By Alan Tovey

12:02PM GMT 16 Dec 2011

The investment trust industry's trade body wants to see annual reports split into two parts: a strategic report no longer than 12 pages and a comprehensive supplementary report, which would be available online.

This change would produce "higher-quality, user-friendly reports which better meet the needs of shareholders", according to the AIC.

With FTSE 350 companies annual reports and accounts averaging 135 pages, the AIC says the measures would also reduce waste and end the huge postal bills sending out reports entail.

Ian Sayers, AIC director general, said: “Today’s annual reports are so long and detailed that investors cannot see the wood for the trees.

"Key information about the business is lost in pages and pages of detail. This complexity harms rather than helps market understanding. A new approach could encourage disclosures which highlight key information which is of real use to investors."

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Under the AIC's recommendations to the Department of Business, Innovation and Skills, the short strategic report would provide an overview of what the company does and how it has performed in the year.

That would be broken down into sections covering: strategy and business model; company performance; principal risks and uncertainties; key performance indicators; key financial information; and a consistency report from auditors

There would also be details of where to obtain the supplementary report on the internet.

The longer report which would be available as a print copy on request and would detail corporate governance, remuneration information, company law disclosures, environmental and social information and financial statements.

"Our approach would mean that the vast majority of investors with less interest in the detail will receive a report they may read and absorb, instead of a tome which does nothing but fill the recycling bin," the AIC said.

The AIC, which has 344 members with assets of £77bn, said its recommendations would not allow companies to hide information and as the full statements would still be available on the internet.

The proposals won support from the UK Shareholders' Association.

Brian Peart, the association's national vice-chairman, said: "The first three pages of a report are what I look at most: the chairman or chief executive's statement and the summary financials.

"I don't want a lot of unnecessary stuff that's just for the board. I want to read about the financial capabilities of the company and whether it's successful or not."

http://www.telegraph.co.uk/finance/personalfinance/investing/8960708/Shareholders-group-calls-for-company-reports-to-be-made-shorter.html

The annual report should be an essential read for all current and potential shareholders to a company.

While the share price tables in the newspaper provide a useful summary of company information, they are limited because their price information is historical and the data only represents part of the company story.  

The share price tables in the business section of  the newspaper provide an excellent summary of key information on a company.  They generally show the previous day's closing price, price range, upcoming dividends, yield and PE ratio.  The detail will vary depending on the newspaper.  By its nature this information is always going to be dated and does not provide an investor with other important elements to the company's story, such as management experience, recent business developments and what their competitors are doing.


What document are these crucial information sources found in:  Director's report, company financial tables, corporate governance report, and largest shareholders table?  Answer:  Annual report.


The annual report should be an essential read for all current and potential shareholders to a company.  It contains key information on the current and expected future health of a company.


http://www.asx.com.au/courses/shares/course_07/index.html?shares_course_07

Focus on reading annual reports. You’ll be richer for it.

100 Ways to Beat the Market #1: Focus on Annual Reports

HOW TO SPEND YOUR TIME

A few years ago, Warren Buffett was on the Fox Business Network discussing the sale of Berkshire’s shares of PetroChina. Fox anchor Liz Claman asked Buffett how he was able to come up with the idea to invest in PetroChina in the first place.

Buffett replied, “Other guys read Playboy, I read annual reports.“

A biography of value investor Peter Cundill was recently published entitled There’s Always Something to Do. Truer words have never been spoken. There always is something to do.

The question is are you doing the right things.

Buffett spends his time reading annual reports. Moreover, he isn’t reading willy-nilly. He’s reading with purpose. Buffett focuses on trying to figure out how much a business is worth.

In the case of PetroChina, in 2002 Buffett figured the whole company was worth about $100 billion. The entire business was selling in the market for about $37 billion. Buffett bought $488 million worth of shares which he sold in 2007 for $4 billion. Buffett earned a 700%+ return on a half a billion dollar investment in five years by sitting in his office and reading annual reports.

How do you spend your time? How many annual reports have you read in the past week?

Being a great investor requires brutal honesty. There’s always something to distract you and get you off your game. Being brutally honest about how you spend your time is the first step to spending it on what really matters.

Focus on reading annual reports. You’ll be richer for it.




Read more here:
http://www.investlah.com/forum/index.php/topic,27399.msg561946.html#msg561946

The real story is in the numbers - get the necessary training to read them

Four times a year, you'll get the report card that tells you

• how the company is doing,
• how its sales are going, and
• how much money it has made or lost in the lastest period. 

Once a year, the company sends out the annual report that sums up the year in great detail.  Most of these annual reports are printed on fancy paper with several pages of photographs.  It's easy to mistake them for an upscale magazine.

In the front, there's a personal message from the head of the company, recounting the year's events, but the real story is in the numbers. 

• These run for several pages, and unless you are trained to read them, they will surely strike you as both confusing and dull. 
• You can get the necessary training from a good accounting course. 
• Once you do, these dull numbers can become very exciting, indeed. 
• What could be more exciting than learning to decipher a code that could make you a prosperous investor for life?

Companies that intentionally mislead their shareholders (this rarely happens) face severe penalties, and the perpetrators can be fined or sent to jail.  Even if it is unintentional (a more common occurrence), a company that misleads shareholders is punished in the stock market. 

• As soon as they realize it hasn't told them the whole truth, many big-time investors will sell their shares at once. 
• This mass selling causes the stock price to drop. 
• It's not unusual for share prices to fall by half (50%) in a single day after the news of the scandal gets out.

When a stock loses half its value overnight, that disturbs all the investors, including the corporate insiders, from the chief executive on down, who are likely to own large numbers of shares.  That's why it is in their best interest to make sure the company sticks to the facts and doesn't exaggerate. 

• They know the truth will come out sooner or doesn't exaggerate. 
• They know the truth will come out sooner or later, because companies are watched by hundred, if not thousands of shareholders. 
• A company can't brag about its record-breaking earnings if the earnings aren't there - too many investors are paying close attention.

How to analyse an annual report

Wednesday September 23, 2009


How to analyse an annual report

Personal Investing - By Ooi Kok Hwa



MANY of us receive a lot of annual reports every year.

Even though we are aware that there is a lot of important information in the reports, not many of us are willing to spend time going through those reports before buying stocks.

Besides, it is quite difficult for some investors, especially those who lack proper financial training, to analyse the financial information.

In this article, we will provide a quick guide on how to analyse an annual report.

Given that there are many ways to dissect an annual report, the following six pointers are just a quick check on the financial health of any listed companies.

Income statement is the financial statement that shows the effects of transactions completed over a specific accounting period.

In this statement, we have three key pointers: the current level of revenue; high growth in revenue; and the profits made in proportion to the level of revenue.

The current level of revenue indicates the size of a company. A company with revenue or sales of RM1bil is definitely bigger than one that has revenue of only RM100mil.

In Malaysia, companies with revenue of RM500mil and above should be considered as more established companies.

High growth in revenue implies that the company has been expanding over the past period.

Assuming the high growth in revenue will eventually translate into high growth in profits, we should invest in companies with higher growth in revenue because this may lead to higher stock prices.

If the overall economy is expanding, avoid those companies that are showing a decline in revenue.

This might imply that the overall operating activities of the companies are declining.

The profits made in proportion to the level of revenue indicates whether this company has high or low profit margins in its products. The profits here refer to the profit after tax or net income.

We should invest in high profit margin companies because high profit margins will provide a cushion to the sudden change in operating environment. A company with revenue of RM1bil and profits of RM10mil is more likely to face tougher challenges in a stiff price competition environment compared with a company with revenue of RM100mil and profits of RM10mil.

Balance sheet is the financial statement that shows a company’s assets, liabilities and owners’ equity at a point in time. The two main pointers in this statement are cash in hand and total borrowings.

Cash in hand refers to the cash or cash equivalent like fixed deposits. If possible, we should invest in companies with high cash in hand and zero borrowings. High cash in hand may imply that the company has high chances of rewarding shareholders with higher dividend payments.

Besides, companies with high cash in hand have more financial stability than companies with very tight level of cash. This explains why most investment gurus like to invest in cash-rich companies.

Total borrowings include the short- and long-term borrowings. Here, we should check whether the company has reported any sharp increase in borrowings during the financial periods. Most companies need to increase borrowings to support their capital expenditure on any business expansion.

However, if a company has been increasing its borrowings each year and the level has far exceeded one to two times the shareholders’ funds, unless its operating activities are able to support the repayments, the company faces very high financial risk.

Cash flow statement shows the sources and uses of cash over the period. One very important pointer in this statement is the operating cash flow.

High operating cash flow implies that the company is generating cash from its operating activities. A healthy company should show high operating cash flow because this number will indicate how much actual cash the company has generated from operations during the period.

We need to be careful of the companies that are showing profits but at the same time generating negative operating cash flows every year. This may imply that these companies have very high receivables. Any economic downturn may cause a sharp increase in provisions on bad debts.

Lastly, investors need to understand that the above six pointers are just a quick guide to analysing any annual report. Serious investors should not only analyse these six pointers. They are advised to scrutinise the reports further for more details.


Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting.

http://biz.thestar.com.my/news/story.asp?file=/2009/9/23/business/4762997&sec=business

Reading an Annual Report

Reading an Annual Report

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:

• Reading a Cash-flow Statement
• Reading a Profit and Loss Account
• Reading a Balance Sheet
• Reading an Annual Report
• Yield and price/earnings ratio (P/E)