How to Analyse an Annual Report?

What Is An Annual Report? How To Analyse Them?

An Annual Report is a document that contains summary of important activities a company has undertaken during the year. It includes financial performance as well.

It is an official communication by the company to its stakeholders. They are a group of people that have an interest in the decision a company make. They are the ones who can either affect or be affected by the company’s operations. For e.g., investors, employees, customers, suppliers, etc.

It is uploaded on the website of the company to provide easy access. To get the annual report visit the website of the company and go to the ‘Investors’ section. Generally, there is a column as ‘Financial and Reports’ or ‘Financial Reports’ in the investors’ section. You can download the PDF version of the annual report from the reports section. Alternatively, you can also contact the company to get a hard copy of the annual report.

What To Look For In An Annual Report?

The annual report has many sections that contain useful information about the company. One has to be careful while going through the annual report as there is a fragile line between the company’s facts and the marketing content that the company wants you to read.

Some of the important sections to read are:

1) Company Profile

The main reason why we must understand a company’s profile is because it answers all these questions-

• Which industry does the company fall under?
• Who are the its clients?
• Which and how many products is the company offering?
• Who are their competitors?
• Check for the its global presence.

It is important to know the company’s structure to make qualitative interpretations. For example, by knowing their competitors, we can compare two companies to shortlist the best one.

2) The company’s vision and mission statements

In this section, you will get to read vision and mission statement, values and goals of the company. These statements are general in nature. Take a look at vision and mission statements of Infosys:

Vision: “We will be a globally respected corporation.”

Mission: “Strategic Partnerships for Building Tomorrow’s Enterprise.”

Some companies also set a vision like “To touch revenues of Rs 5000 crore in 5 years.”

3) Overview of products and financial highlights over the last 5 to 10 years

Get details of products being manufactured by a company, segment wise performance in last two years, key raw materials consumed, etc. Some companies publish financial highlights of 5 to 10 years in annual reports. You will get to analyse trend of revenue, earnings before interest, tax, depreciation and amortization (EBITDA), profit after tax (PAT/Net income / loss) from income (profit and loss) statement and also get a glimpse on shareholders equity, assets, debtors, liability and total debt from balance sheet over the years. Important ratios are also presented in charts over 5 to 7 years time line.

4) Director’s Report

This part includes a financial summary, an explanation of the financial results, and major company developments. The company’s operational indicators, such as capacity additions, capex plan / completed during the year, order book as of financial year end, average length of stay, occupancy rates, average revenue per occupied bed, average revenue per user, and so on, are key items to look at in this section.

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. 

5) Management discussion and analysis (MDA)

The management commentary, or MD&A is one of the most useful parts of a company’s annual report. The company’s management shares their opinions, challenges & outlook in this section. Further, the management discusses company’s goals and new projects they intend to undertake.

It is recommended that you read at least 3-5 years of MDA to gain a better understanding of the company’s tendencies in various economic scenarios.

6) Corporate Governance Report

This section discusses a company’s corporate governance, including the board of directors’ composition, background information on the company’s directors and independent directors, attendance of directors at board meetings and annual general meetings, remuneration of directors, re-appointment of directors after the term ends, and the composition of sub-committees.

Few questions that investors may consider while assessing corporate governance:

• Who represents shareholders on the company’s board?
• Who are the significant investors in the company?
• How strong are the shareholder rights?
• Check their policies and Credit Rating.
• How is the company managing long-term risks? (such as managing human capital, long- term sustainability, etc.)

7) Information about the company’s stock

This section contains data on the company’s historical share price performance, share holding pattern, promoter pledging of shares during the year, share splits, bonus shares distributed, and so on.

8) The auditors’ report

It contains information about the company’s financial statements as well as auditors’ opinions. You want to know who the company’s auditors are and if they have any qualifications for internal processes. This section will identify any changes in accounting policy that have occurred.

9) Financial statements

Financial statements are one of the most important aspects of an Annual Report. There are three financial statements that the company will present namely:

• The Profit and Loss statement
• The Balance Sheet and
• The Cash flow statement

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.

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.

10) Notes to accounts

In this section, you’ll learn about a company’s accounting policy, depreciation, currency losses and gains, segmental reporting, inventories, liabilities, and leases, among other things. Reading the notes to account part of the last three to five years can be beneficial. This will aid in obtaining information on any changes in accounting year or accounting policy that may inflate the company’s sales or profits, trend in segmental revenues / profitability, contingent liabilities over time, linked party transactions, and so on.

For the first time, reading an annual report may seem like a tedious task. However, it is recommended that you review at least two to three years of a company’s historical annual reports to learn everything there is to know about the company’s operations, financials, and management’s perspective on major economic trends. A corporate and analyst presentation available on the company website is a useful source of information, as is reading an annual report before deciding whether to purchase, sell, or keep stocks.