Company’s annual report is a comprehensive document that summarizes its financial performance over the past years. Company’s annual report typically includes management discussion and analysis, auditor’s report, message from CEO and board of directors, and key financial data like the balance sheet, income statement, and cash flow statement.
Annual report is published by the company for investors, stakeholders, and analysts to evaluate a company’s health and make informed decisions.
Where to find the annual report of a company?
The best place to find a company’s annual report is its website. Typically, it’s available under the investor relation section.
Public companies are required to file their financial statements with the stock exchange and government. You can download these from the stock exchange and government sites.
In this article, we will be discussing 10 most important things that you must read in a company’s annual report before making any decisions.
CEO’s letter to shareholders
The CEO’s letter to shareholders addresses growth, innovation, financial performance, competition, regulatory challenges, economic conditions and other challenges.
You as an investor must assess how the CEO discusses financial results. Compare these parameters to past performance and industry benchmarks. Find out if the long term goals and strategic initiatives are realistic and aligned with the present market situation.
Understand how the CEO plans to enhance value for shareholders.
Compare the letter to those of other CEOs in the same industry.
Director’s report
In addition to a summary of financial information like revenue and profit margin, the director’s report will give you certain key performance indicators (KPIs).
You need to compare these figures with industry benchmarks and previous years.
Understand how they have discussed growth, cost reductions and market expansion. Evaluate if these are realistic and align with the market trends and company’s present strength.
In case of any potential risk, review how they are going to address these.
Analyze how the guidance and forecasts will impact the company’s future profitability. Check if they are realistic.
Check how the director’s report discusses market opportunities and anticipated challenges. Compare the report with similar industries to gain insights into industry performance.
Management’s discussion and analysis
In management’s discussion and analysis section of the annual report, you will find discussions on revenue, profit margins, expenses, cash flows, commentary on operations, including production efficiency, supply chain issues, and customer demand.
Investors need to analyze these details to identify challenges faced during the period and how the management plan to address them.
Look for information on strategic initiatives taken by the management to remain profitable and acquire market share. Compare it with the competitors.
In case of any mergers and acquisitions plan, evaluate how it will impact profitability and growth.
Pay attention to the forward looking statements where the management discusses projections and guidance. Analyze if these forecasts are realistic and achievable.
In addition to the CEO’s letter, director’s report and management discussion, you will have the company’s financial statements.
Here are the three main financial statements you will find in the annual report:
- Income statement (profit and loss account).
- Balance sheet
- Cash flow statement
Income Statement
Income statement of a company will give you a clear understanding of the company’s financial health and potential investment opportunities.
From an investing prospective, investors must focus on following key elements:
- Revenue and net profit.
- Top line and bottom line growth rate.
- Gross profit and margin.
- Net profit and margin.
- Earning per share (EPS)
In order to assess relative performance and operational efficiency, investors need to compare the income statement metrics with industry peers.
Horizontal and vertical analysis of a company’s income statement will help you to understand financial performance for a period.
Balance Sheet
Balance sheet published in a company’s annual report, is a financial statement that provides a snapshot of a company’s financial position at a specific point in time. It consists of assets, liabilities and equity.
The fundamental equation of a company’s balance sheet is:
Assets = Liabilities + Equity
This equation ensures that the balance sheet is always balanced, reflecting the company’s financial health.
Here are the steps to follow get a deeper inside to balance sheet:
- Examine each and every item of current assets, current liabilities, non current assets, long term liabilities and shareholders equity.
- Calculate current and quick ratio to understand short term liquidity position of the company.
- Calculate debt to equity ratio and interest coverage ratio to have a clear picture on a company’s financial risk.
- Prepare horizontal and vertical analysis to understand the company’s financial position.
- Compare the balance sheet metrics over multiple periods to identify trends.
- Assess the proportion of intangible assets (like goodwill) relative to total assets.
Cash flow Statement
Cash flow statement published in the company’s annual report, gives a clearer understanding of cash management, operational efficiency, and overall financial health. These elements are very critical for making informed investment decisions.
In a cash flow statement, you will get following details:
- Operating Cash Flow (OCF)
- Cash Flow from Investing Activities
- Cash Flow from Financing Activities
OCF shows you cash flow from the company’s operating activities. In this section investors can examine cash generated from a company’s core business operation.
In the cash flow from investing activities section, you analyze cash spent on capital expenditures (CapEx) versus cash received from asset sales.
Cash flow from financing activities shows cash raised through debt or equity and cash paid out in dividends or debt repayments. This section reflects the company’s financing strategy and capital structure.
Net cash flow, which is calculated by deducting total cash outflows from total inflows, indicates strength of the company’s financial stability. Positive net cash flow shows strong financial stability.
Free cash flow which is calculated by deducting capex from operating cash flow indicates how much cash is available with the company for expansion, dividends, or debt reduction.
Investors should compare cash flow figures over multiple periods to identify trends. Look for a company with consistent growth in operating and overall cash flow.
Calculate Cash flow margin and cash return on assets. Both will help you in understanding the operational efficiency of a company.
Cash flow margin is calculated by showing operating cash flow (OCF) as a percentage of revenue.
Cash return on assets is calculated by dividing operating cash flow (OCF) by total assets.
In order to know the quality of earnings, compare net income to operating cash flow (OCF). A significant divergence might indicate that earnings are not being converted into cash, raising red flags about revenue quality.
Notes to the financial statements
Notes to the Financial Statements in a company’s annual report includes accounting principles the company uses for financial reporting, breakdowns of major line items in the financial statements, potential liabilities or future obligations, related party transactions, revenue and profit details by segment, and other details.
Analyzing notes to the financial statements in an annual report is crucial for gaining a deeper understanding of a company’s financial position and performance.
You need to look for disclosures about key estimates and judgments made by management that can affect financial results. Analyze how the company values its assets, including property, plant, and equipment, and intangible assets.
Assess disclosures related to liabilities, such as debt, lease obligations, and contingent liabilities. This helps gauge financial risk.
Review the segment information to understand the performance of different business areas and their contribution to overall results.
Auditor’s report
An auditor’s report is a formal opinion issued by an independent auditor after reviewing the company’s financial statements and operations.
The auditor gives an opinion whether the financial statements provide a true and fair view of the company’s financial position and comply with relevant accounting standards.
The auditor’s report is a crucial part for stakeholders, such as investors and creditors, as it provides assurance about the reliability of the financial statements.
Examine the auditor’s opinion. Typically auditor can give four types of opinion:
- Unqualified Opinion: This type of opinion indicates that the company’s financial statements are fair and comply with accounting standards.
- Qualified Opinion: This type of opinion suggests that, except for specific issues, the financial statements are generally fair. In this case, as an investor you need to investigate the reasons for qualification.
- Adverse Opinion: If the auditor finds any serious red flag in the company, then they may issue an adverse opinion. This type of opinion indicates significant issues with the financial statements. You need to consider adverse opinions very seriously.
- Disclaimer of Opinion: This type of opinion arises when the auditor could not form an opinion, often due to insufficient evidence. This requires further investigation.
You need to look for any significant findings or recommendations noted in the auditor’s report. These can provide insights into areas of concern or improvement.
Company’s corporate governance
Corporate governance section in an annual report is essential to know how the company is managed, ethical practices followed, and its commitment to transparency and accountability.
Examine the composition of the board, including the number of independent directors, their qualifications, and diversity. Review the roles and effectiveness of key committees such as the audit committee and governance committee.
Evaluate the transparency of disclosures regarding governance practices, executive compensation, and potential conflicts of interest.
By analyzing the corporate governance section in the annual report, you can gain insights into the company’s commitment to good governance, ethical practices, and how effectively it manages risk and stakeholder relations.
Additional disclosure
By examining certain additional disclosures, you can gain a comprehensive understanding of the company’s operations, risks, and overall financial health, allowing for more informed decision-making.
Additional disclosures in annual reports include legal proceedings, regulatory issues, or environmental, social, and governance (ESG) factors that could impact the company’s performance and reputation.
You will find certain additional disclosure that provide valuable insights into a company’s operations, risks, and overall health. Here are key areas to focus on:
- Information on potential liabilities, lawsuits, or regulatory issues that could impact financial health.
- Transactions with related parties, which can highlight potential conflicts of interest or financial risks.
- Potential risks facing the business, including market, operational, and regulatory risks, which is crucial for assessing future performance.
- Dividend policies, stock performance, and shareholder voting rights.
- Details on how executives are compensated, including salary, bonuses, stock options, and performance incentives, which can indicate alignment with shareholder interests.
