The annual report as the name suggests is a yearly document that a publicly traded company must provide to its shareholders. It contains all material events of the previous financial year along with the financial statements. In the report, the management also talks about the growth opportunities for the company, future expectations, and risks.
Imagine the annual report as your performance report in school. If you did well, your parents would celebrate your achievements and if not, you would have to go looking for a place to hide. In the case of a company, it’s the shareholders and stock analysts who will either cheer its performance (company’s shares will get a boost) or dismiss it (investor confidence will take a knock).
As legendary investor Warren Buffett noted in a Berkshire Hathaway annual shareholder meeting: “I would like to have a report that would be identical to what — if I owned half of a company but was away for a year, and I had a partner who owned the other half — when I came back, that he would tell me about what had taken place during the past year and what he foresaw coming up and all of that.”
“I don’t think we’ve ever gotten an idea, you know, in 40 years from a Wall Street report. But we’ve gotten a lot of ideas from annual reports,” he added.
A company’s annual report is published at the end of the financial year. So, in India, for example, it contains all the data available for any business till March 31 of any fiscal. It is required for all companies registered under the Ministry of Corporate Affairs (under Section 217 of Companies Act, 2013) to present an annual report every year.
The annual report is a public document, meaning it is available to everyone who wishes to see it. Current and potential investors use it to evaluate the firm's financial performance and/or to make investment decisions.
You can download the annual report in PDF format from the company's website or the website of BSE or NSE. You can even contact the company to get a hard copy of the annual report.
Now, let's discuss the contents of an annual report. The annual report of one company can differ from that of another company. While there is no set structure for annual reports, a few sections will typically appear in all annual reports. Following are some of the common sections:
Corporate information
Here you get an overview of the company. Its business, where its located, number of employees, and other general information that gives you the big picture of what the firm does and where it operates.
Operating and financial review
Sometimes referred to as financial highlights, this section gives you a snapshot of the company's financials from the fiscal gone by.
The company details achievements during the year and over the past few years in the form of graphs or charts through a comparison of key metrics such as revenue, profit, market capitalisation etc. This gives you a sneak peek at how the company has evolved over the last few financial years.
Think of it as a synopsis of the financial statements. The management also sometimes includes a few financial ratios.
The company may also talk about initiatives that could help improve value in future, awards received during the year etc. in this section.
Management Discussion & Analysis
In this section, the company management discusses the business and the industry it operates in. It also talks about future goals, objectives and strategies and how they plan to implement them.
This is important as it gives investors and potential investors a sense of the vision of the management and what it perceives as threats and opportunities. It also helps them understand the position of the company in the industry.
Chairman’s message
This chairperson of the company shares insights into the trends in the business and industry, new initiatives the company has taken to stay competitive, among other things. They also about the external factors affecting the business such as changes in the labour market, economy or global supply chain.
Both Chairman’s message and management discussion & analysis usually give a broad-based idea of how the business is positioned and give a sense of where it may be heading.
Some managements tend to paint a rather rosy picture on the state of the business. It is therefore important to validate it by looking at the actual financials over the past few years.
So, if a company has undergone any major change or been through a tumultuous period then it will be advisable to see if the management has clearly listed out the challenges and appears confident of overcoming them.
Corporate governance report
This section lists the powers, functions, roles and responsibilities of the board of directors and the management of the company. Here, the readers of the annual report get an idea of who the people behind the business are, their expertise and how the corporation enables them to perform their duties.
In this section, you could look out for key employee salaries and benefits, including how much stock they receive.
Financial statements
This is perhaps the most important section of the annual report. A company presents three financial statements - income statement or profit and loss account (P&L), balance sheet and cash flow statement. Apart from these, there are also notes to financial statements.
P&L details the income, expenses and profit/loss of the business. Balance sheet is an account of all the assets that the company owns and the liabilities or what it owes. Cash flow statement as the name suggests how much cash the company is generating and how it is utilising the cash.
We will discuss each of these three statements in detail over the next few chapters.
Auditor's report
This section summarises the findings of an independent auditor or audit firm. This provides additional assurance to readers of the annual report that the numbers provided in the annual report are fair and accurate.
Auditor’s report can be unqualified meaning financial statements are free from material misstatements, qualified i.e., certain statements could not be independently verified by the auditor or are misstated. It can also be adverse -- meaning misstatements are material – or come with a disclaimer of opinion where the auditor is unable to obtain sufficient audit evidence on which to base the opinion.
Accounting policies
Here the company talks about how it maintains its books of accounts, handles reporting and the accounting policies it follows. It will detail how the inventory is maintained, the creditor/debtor policies etc.
Conclusion:The annual report gives a host of information about a company and can run into hundreds of pages at times. While it is not necessary for you to go through every page, a broad idea of the things that you need to watch out for should give you a good sense of what the company is up to and how it can fare compared to competitors.
