Reading an Annual Report

Publicly traded companies are required by law to publish an annual report to their shareholders. Many companies publish quarterly reports as well. Though there is no government mandated format that an annual report should take or the exact information it should contain, custom has developed some standards, and some professional accounting organizations have required compliance with certain formats to be considered “generally accepted”.

Typically, the report will begin with the Chairman’s letter. This should note significant developments over the period being reported and plans and predictions for the next period.  In a large company, the operations of various segments or operating centers will be described and commented upon.

The next, and to some the most important section of an annual report is the financial section. This will contain the profit and loss statement (the P&L, or income statement), the balance sheet and the cash flow statement. The P&L lists all of the summarized income and expenses for the firm, and the net profit or loss resulting from the difference.  The level of detail for the income and expenses differs for each company, making it difficult to determine the factors responsible for the profit or loss. In addition, varying and sometime unorthodox treatment of some types of costs may mask underlying problems the company is experiencing. These are the types of issues that covered up the problems with Worldcom, Adelphia and Parmalat in recent years.

The next section of an annual report is the Balance Sheet, which lists all of the assets and liabilities of a company. The difference between the assets and liabilities of a company is the company’s net worth. This has also become an area of reporting controversy when creative accounting has allowed some companies to capitalize some expenses (in other word, make them long term assets) instead of treating them as current (in other words, putting them on the P&L).  The Balance Sheet has always been described as a “snapshot” of the company; if an acquisition is made on January 1 and the annual report is as of December 31, that asset will not be reflected. Accountants should use footnotes to inform the shareholders of any pending items such as this as well as lawsuits or other items that may have a material effect on operations. Valuable information about the organization’s financial status is often found here even if it is not obvious in other parts of the report. Information on a management reorganization may signal problems in the executive suite, or a bad debt that was written off by the company may only be seen in the notes since it was included in a summary expense line.

The final segment of the report is the auditor’s letter confirming that a Certified Public Accounting firm (CPA) has deemed the information to be accurate and presented under the relevant accounting principals. Any qualifications presented by the auditor should be carefully evaluated.

Remember that the annual report is published by the company itself, and by its Public Relations Department, at that. They are the ones who are paid to make the company look good. So, make sure you get your information about the company through other means, such as the business press or independent analyst’s reports.

Categories Accounting, Business, Investing and Financial Planning

One thought on “Reading an Annual Report”

  1. It is a detailed document of what a business owns, what it owes, and who that money belongs to. Though there is some tricky. How to Read a Balance Sheet via Very useful for just learning the basics of how to read a balance sheet.

Leave a Reply

Your email address will not be published. Required fields are marked *