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

Four Key Questions when using Financial Information and Interpreting Accounting Ratios

There are many traps in using financial information and interpreting accounting ratios.

You are advised to approach the job with caution and always keep in mind four key questions:

1. Am I comparing like with like?
2. Is there an explanation?
3. What am I comparing it with?
4. Do I believe the figures?

1.  Am I comparing like with like?

Financial analysts pay great attention to the notes in accounts and to the stated accounting policies.

One of the reasons for this is that changes in accounting policies can affect the figures and hence the comparisons.

For example:

• Consider a company that writes off research and development costs as overheads as soon as they are incurred.
• Then suppose that it changes policy and decides to capitalize the research and development, holding it in the Balance Sheet as having a long-term value.
• A case can be made for either treatment but the change makes it difficult to compare ratios for different years.

2.  Is there an explanation?

Do not forget that there may be a special reason for an odd-looking ratio.

For example:

• Greetings card manufacturers commonly deliver Christmas cards  in August with an arrangement that payment is due on 1 January.
• The 30 June Balance Sheet may show that customers are taking an average of 55 days' credit.
• The 31 December Balance Sheet may show that customers are taking an average of 120 days' credit.
• This does not mean that the position has deteriorated dreadfully and the company is in trouble
• The change in the period of credit is an accepted feature of the trade and happens every year.
• It is of course important, particularly as extra working capital has to be found at the end of each year.

3.  What am I comparing it with?

A ratio by itself has only limited value.

It needs to be compared with something.

Useful comparisons may be with the company budget, last year's ratio, or competitors' ratios.

4.  Do I believe the figures?

You may be working with audited and published figures.

On the other hand, you may only have unchecked data rushed from the accountant's desk.

This sort of information may be more valuable because it is up to date.

But beware of errors.

Even if you are not a financial expert, if it feels wrong, perhaps it is wrong.

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).

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

Do not underestimate the value of due diligence

If and when you decide to pursue investing or whatever your fancy, do not underestimate the value of due diligence.

Look through each and every financial statement you can get your hands on, including the detailed notes.

If you just read the annual reports of companies, you will have done more than 98% of investors.

If you read the notes of the financial statements, you will be ahead of 99.5%.

Verify those financial statements, as well as future projections announced by the top executives, by doing your own legwork.

Talk to customers, suppliers, competitors, and anyone else who might affect the company.

Do not invest unless you can say with absolute certainty that you are more knowledgeable about his particular firm than 98% of the analysts!

Wednesday March 10, 2010

How to analyse company statements and reports

Personal Investing - By Ooi Kok Hwa

Analysts usually judge the quality of a company’s management team by looking at the comprehensiveness and truthfulness shown in the management statements

FOR the next few weeks, investors will start to receive annual reports for companies that have their financial year ended Dec 31. Even though the majority of investors may not look at those reports in detail (in fact, some investors may not even open the envelope containing the annual reports), some people will still spend time analysing the whole report. One of the key sections that investors will analyse in detail is the chairman’s statement and management discussion or operations review. In this article, we will label the above statements as management statements.

Most of the management statements will explain the companies’ immediate past one-year financial performance, external environment, major corporate developments as well as the companies’ future prospects.

Based on our observations, the majority of companies will try to explain and highlight a lot of positive elements that happened in the companies. It is very rare to find negative issues that affect the companies’ performances being discussed in the statements. Even though we cannot conclude that those companies that are willing to highlight their financial problems as good companies, at least these companies show their effort in trying to be truthful to their investors. This will provide a lot of plus points to these listed companies.

Analysts usually judge the quality of a company’s management team by looking at the comprehensiveness and truthfulness shown in the management statements.

Nowadays, if there are areas that a company does not comply with the accounting standards, the external auditor will highlight those areas inside the auditor report. Hence, investors need to read the management statements and financial statements together with the auditor’s report.

The management statements will normally provide the reasons driving the companies’ overall performance, whether good or bad. However, there are certain companies that tend to focus on higher sales and avoid mentioning the profitability when ever they report lower profits during the year. They will try to avoid the reasons causing the reduction in profits, for example, higher operating costs, raw material costs or stiff price competition.

Some times, some companies will claim they have managed to maintain profits at the same level as the previous year. However, if we further analyse the financial statements, we will notice that the profit had included a lot of exceptional items, such as gains from the disposal of fixed assets as well as investments. Hence, we should not rely on the explanation given by the management in the chairman’s statement.

In fact, we need to investigate further the driving factors for the profitability of the company, especially if it had included some exceptional gains or losses, which are not part of the company’s normal operations. These details can be found in the notes to the accounts. Normally, most companies will list the key items that affect their profitability in the notes to the “profit before tax”.

We can get a summary of key corporate developments that happened in the company in the “corporate development” section. If you have been following the company’s corporate developments, this section may not provide you a lot of new information.

Nevertheless, certain companies may provide the latest status of their corporate developments, such as any new projects being initiated or certain approvals from relevant parties being granted for their critical projects.
As for the section on the company’s future prospects, investors should not place too much weight on it. Based on our experience, a lot of Malaysian companies have the same statement on future prospects by saying that “the company will perform better in the future”.

There are companies that have reported losses every year but the chairmen will still say the companies would perform better next year without the backing of solid grounds to improve profitability.

Hence, a good company statement should provide a fair account of the actual happening in the company. In reality, it is quite difficult for listed companies to hide their problems as the level of financial literacy of the general public has improved over years.

There are some mature investors and analysts who are able to detect the problems faced by the company by analysing the notes to the accounts in addition to making comparison of the current financial statements versus the statements or quarterly financial statements of past years.

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

http://biz.thestar.com.my/news/story.asp?file=/2010/3/10/business/5827481&sec=business 

DIS Technology - Check List: What can we learn from this ugly saga?

As with Transmile, it is sad that the investors are again caught in such a fraud.  There must be heavy penalties for those involved, not least, to emphasize the seriousness of this matter and to deter future such happenings.

Could this fiasco, of false accounting, be predicted looking at the latest quarterly reported results?  Often the answer is NO, though it was obvious that the company's business was deteriorating and the balance sheet was not good quality. 

The revenues and earnings were manipulated in the accounting.  However, the cash flow statement would have indicated that not all is well with the company.  The CFO was strongly negative.

http://spreadsheets.google.com/pub?key=tZmdsnrXUbsFVCAmAaQRW4g&output=html

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Blogger Wisdom Wise has written a nice article on reading the annual report which I have copied and paste here:

Tuesday, March 09, 2010

Reading the Annual Report

When you look at a woman, which part of her anatomy do you look at first? Is it her face, her bosom or her bottom? It is all a matter of choice. It doesn't matter so long as you get to look at the whole picture. Now, when you look into an annual report, it is the same. Which statement do you prefer to see first. Is it the income statement, the cash flow statement or the balance sheet? Personally, I go straight for the balance sheet to find out what the company has and what it owes others. If I don't find things attractive there, I will just close the report, avoid the stock and move on.
The things that I pay attention in the balance sheet are: Paid-up capital, par value per share, retained earnings, current assets, and current liabilities. I pay special attention to its cash position and how much debt it has. If its debt is too high, when compared to its equity, I will normally lower the grading of the stock. Don't forget that all companies that folded are those with very high debt.
From the balance sheet, I go to the income statement , the cash flow statement, and then the CEO's statement, or Chairman's statement. If both are available, I'll read them both and also the notes in the annual report to ascertain that the company is not involved in any litigation. Lastly, I will go to the page that shows the names of the majority shareholders. A strong major shareholder is a advantage. Take the case of YTL Cement whose major shareholder is YTL Corp.
Things to consider when assessing a company are as follows: a) Calibre of management; b) Modal of business; c) Earnings per share; d) Dividend yield; e) Cash and debt position; f) Barrier of entry; and g) sustainability of profit.

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.

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)