There was a time when annual reports would arrive by post at your doorstep and that distinguished you as a savvy stock investor. That is no longer the case. Most annual reports nowadays are either emailed online or you are provided with a link to read the annual report on the company website. Either ways, the annual report still remains the same although fewer trees have to be cut down. But that is not the point here! The point is how to read the company annual report and how to go about understanding annual reports of companies? Let us look at 8 segments of the annual report that offer an in-depth and incisive analysis of annual report of a company. After all, an annual report is your window to your investment and you must make the best of it. Here are 8 things you must read closely..
This is the first relevant segment of the annual report where the board of directors puts out the key business themes for the year, an analysis of the financial performance, key return parameters. This segment is important because it provides you a quick analysis of how the company top brass looks at the business and that is perhaps the best way for you to judge the attractiveness or otherwise of the business you are invested in.
Management discussion and analysis (MDA)
The MDA is perhaps the most important part of an annual report. Reputed companies take great pains to reveal the true picture of the present and the future of the company through the MDA. This segment focuses less on financials and more on the business environment, the strategies of the company, the emerging structure of competition, the game plan of the company in the coming years, the implications etc.
Vision and mission statement of the company
Nothing gives you a better understand about the quality of the management than the vision and mission statement of the company. Good companies survive on profitability but great companies thrive due to their vision and mission. A mission statement is something the company applies to its strategy and products on a regular basis. The vision statement is where the management sees the business in the overall social and business hierarchy.
Income statement and Balance sheet
The proof of the pudding lies in the eating. The income statement and the balance sheet are the flow and stock of the business. It shows you how profitable the business is and how much return on assets the company is generating. Don’t just read the raw numbers on the financial but also read the notes to the accounts. Remember, a lot of the devil in any company’s financial statements lies in the fine print and the notes to accounts contains all the fine print of the company annual statements.
Cash flows statement
Your company may have generated fantastic profits but is that really generating profits for the business. That is what cash flow statement is all about. It is divided into 3 sub-segments viz. Cash flow from Operations, cash flow from investing and cash flow from financing. The purpose is to see to what extent the positive cash flow from operations are sufficient to finance the negative cash flow from investing and what is the shortfall that has to be funded by cash flows from financing. This statement is the best summary of the health and sustainability of the business you are invested in.
Contingent liabilities and auditor qualifications, if any
What are contingent liabilities? They are called off balance sheet items. These are not liabilities but have the potential to become liabilities subject to certain conditions. For example, the company may have given a guarantee which will become a liability if the borrower defaults. The company may have legal cases pending against it which could become a liability if the case is lost. Many companies try to use off balance sheet funding to make the balance sheet look attractive as Enron did before going bankrupt. You need to watch out for that.
Report on corporate governance
Corporate governance is all about ensuring that the actions of the promoters and management of the company are aligned to the interests of the minority shareholders. The annual report is statutorily required to give a Corporate Governance report based on the discussions of the Corporate Governance Committee. This gives you a fantastic insight about the alignment of the management actions with the shareholder interests. This report also highlights the standards of ethics followed by the company. Normally, it has been observed that companies that adhere to high standards of corporate governance tend to get better valuations in the market.
Information on shares of the company
The annual report is also required to make a disclosure of information on shares which includes the averaging trading price and the average trading volumes. The report also gives the statement of ownership shifts. This is critical. You can gauge if the promoter stake is gradually reducing or if major institutions are selling out. These can be red flags for you.
In a nutshell, the annual report of a company is a storehouse of information and insights about the company. As an investor you must spend the time and energy to go through the finer aspects of the report.