The annual report provides a wealth of information on a company. Looking at just the financial statements gives you the figures, but you want to know what's behind the figures and what they mean. The management discussion and analysis can give you some valuable insights. And the notes to the financial statements in the annual report can be enlightening.
Each company's annual report reflects its own style, but there are common components. The annual report includes a letter from the chairman, one or more sections describing the company and its operations, the financial statements, the notes and an independent audit opinion.
How the Chairman sees things
The annual report starts with a letter from the chairman. This is a high-level statement of the company's achievements, major changes during the year, market conditions, challenges the company faces and the road ahead. Note that "challenges" can sometimes be interpreted as "opportunities" and other times as "we may have a problem here."
What the company does
The annual report is also a public relations tool for a company. You can entertain yourself with the catchy corporate phrases and the wonderful pictures splashed generously through the section describing the company and its activities. Many companies include a vast amount of information in this section of the annual report.
Look for information on the company's products, technologies, innovations, market segments, geographical locations, research and development, environmental commitment, social responsibility and growth prospects. Interpret how all this contributes to the company's competitive advantages.
10-K Report to the SEC
All publicly traded companies in the United States must submit an annual report, known as the 10-K, to the Securities and Exchange Commission (SEC). Some companies include the actual 10-K in their annual report while others include the same information in a different format.
The risk factors in the 10-K annual report are not intended to scare you off as an investor. All companies have risks. But the conditions that could affect the company's future performance help you put things into perspective. The section on legal proceedings can alert you to any pending litigation that could have a significant impact on the company.
Management's discussion and analysis of financial condition and results of operations is especially interesting. This section of the annual report gives you a more in-depth look at what's behind the numbers on the financial statements, as management explains what happened during the year.
The financial summary in the annual report shows overall net sales, operating income, assets, debt, capital expenditures and some financial ratios from the income statement. This summary also includes some key indicators, such as earnings per share (basic and diluted), dividends per share and the stock price at year-end.
Crunching the numbers in financial statements
The three principal financial statements in the annual report are the balance sheet, income statement and cash-flow statement. The balance sheet shows the company's financial position-its assets, liabilities and capital-at a given point in time. The income statement shows the company's revenues, expenses and net income, i.e., the bottom line. The cash-flow statement shows the money moving in and out of the company, broken down among operations, investing and financing activities.
You can use this information to perform your own financial analysis of the company. Calculate the Current Ratio by dividing a company's current assets by its current liabilities. If the resulting ratio is high, it means that there are lots of assets available and short-term risk is potentially lower. If the Current Ratio is low, it often means that the company's assets are being used for growth, which can potentially be valuable in the long term.You can also calculate the Debt Ratio by dividing the company's total debt by its total assets. Comparing this ratio to the total debt can help you see how stable a company is. A high debt ratio and low assets mean that a company is relying heavily on credit to stay afloat; this could mean higher risk and volatile returns. A low debt ratio and high assets potentially mean that the company can weather financial storms.
Digging into the notes
The notes in the annual report are where you can really get into the nitty-gritty of what's behind the figures. Many of the notes deal with accounting methods and are quite standard. Other disclosures provide additional breakdowns of the amounts in the financial statements.
In reviewing the notes on accounting methods, look for critical accounting policies or estimates. You can also watch for any change in accounting methods, and see why the change was made and the effect it has on the company's reported earnings.
Breakdowns of income by business segments and geographical areas can highlight where the company is most or least profitable and where its growth potential lies. Other notes provide detailed breakdowns of items such as inventories, property, plant and equipment, debt, pension obligations and income taxes.
The note on exceptional items highlights the effect any significant events, such as mergers, acquisitions or divestitures, had on the company's results. Look at the note on contingent liabilities and commitments to find potential obligations not included in the balance sheet.
Are the auditors on board?
The independent auditors' opinion in the annual report follows a standardized format. You want to see that the financial statements "present fairly" the financial condition of the company, the results of its operations and its cash flows. Any qualification to the auditors' opinion should be clearly pointed out and explained.
What you need as an investor
If you can't find data such as total market capitalization, price-to-book ratio, price-to-earnings (P/E) ratio and price-to-sales ratio in the annual report, you can calculate them yourself. For total market capitalization, multiply the number of shares issued (from the balance sheet or notes) by the year-end stock price.
Price-to-book ratio is total market capitalization divided by stockholder's equity. Total stockholder's equity is what the company is worth according to the books. A P/E ratio of less than one means the stock is selling for less than it's worth.
The price-to-sales ratio is total market capitalization divided by total revenue. The higher the ratio, the more expensive the stock is in terms of sales. A higher ratio may be fine if sales are growing. You can check that by calculating the percentage rise in sales from year to year.
If it feels like work, it is. As a prudent investor, you need to do your homework.
 | Annual reports are your pipeline directly into company objectives and performance. If you're considering investing in a company, or want to know how your investment is doing, an annual report is the first place you should look. What can you learn from an annual report? You might be surprised. |
 | Whether you are researching a company to invest in or you hold shares with a company and want to see how their affairs are going, getting a copy of the annual reports can answer any questions you might have. |
Even if you are an avid investor, nothing is more boring than a company's annual report. Reading an annual report is like eating your veggies. Luckily, unlike eating your veggies, you can skim an annual report for crucial information. |
Corporate annual reports provide investors with a wealth of information, combining a company's yearly financial performance along with the company's commentary on both past and present performance. Before investing in a company, you should obtain a copy of the company's annual report and read it thoroughly in order to get a better feel on the company and its current situation. |
When it comes to writing a business report, knowing the intended audience is critical in determining how to proceed, and then making sure the finished product meets the readers' expectations. More than likely, your boss assigned you the project of preparing the report for analyzing the business, and you need to start by making sure you know what their goal is in having you prepare the report. |
