Preparing Annual Reports
The law says that all companies must produce an annual report, to keep shareholders up-to-date with how the company is performing.
Information that it must contain includes: profit and loss account (P&L), balance sheet, cash flow statement, directors' report, and auditors' report. My companies also include general information not required by law, which usually interprets the statutory information in the most favorable possible light.
Private companies are not required to publish as much detail as public companies, so their annual reports tend to be shorter. Private companies are not usually concerned with PR either—so more often than not, they do not include additional interpretative sections.
There will be an element of propaganda in any large corporate annual report. However, the auditors' report is a statutory requirement—and since auditors are independent accountants, their investigation of the company's financial position should result in an accurate, balanced view. Of course, it is impossible for auditors to check every transaction, but risk-based analyses and techniques like statistical sampling enable them to evaluate the integrity of the company's management and systems.
The standard format of annual reports may vary between countries. However, in the U.S., they usually contain the following sections:
- Introductory section
- Chair's report
- C.E.O.'s report
- Financial review
- List of directors
- Directors' remuneration report
- Statement of directors' responsibilities
- Auditors' report
- Financial statements
- Five-year financial summary
- Shareholder information
Introductory section—produced by the PR department, this is an overview of the company, the products or services it sells, and the markets it sells to.
Chair's report—commentary on the year just finished, and on future prospects. Includes annual results and details of earnings per share and dividend payments.
C.E.O.'s report—a more detailed look at specific areas of the company, with results from different divisions, new areas of business and any discontinued operations.
Financial review—quantitative analysis of aspects of the company's financial position. For example, it may comment on how the company's profits, resources and debt have been affected by things like cash flow, interest rates, and exchange rates. Anything out of the ordinary—like the sale of one of the group's companies—will also be highlighted.
List of directors—includes a brief resume and photo for each member of the Board.
Directors' remuneration report—report from the company's remuneration committee—a group of non-executive directors responsible for deciding how much senior staff and directors should be paid. They focus on areas like contracts of employment, bonus packages, share options, and pension arrangements. The report should give details of each director's pay, bonuses etc, with last year's figures for comparison.
Statement of directors' responsibilities—a statement required by law, which sets out the precise obligations of the company's directors in relation to its financial reporting.
Auditors' report—follows a standard format.
Financial statements—the reason that annual reports are published. Typically, they include:
- Profit and loss accounts—where a company has several divisions, their individual P&L accounts are usually consolidated into one.
- Balance sheet—the parent company's balance sheet may be accompanied by one consolidating the whole group.
- Cash flow statement—describes how the company made use of the money flowing in and out; again, may be consolidated for the whole group.
- A statement of the management's responsibility for financial reporting.
- Discussion and analysis of the statements.
- Notes enlarging on issues raised by figures in the financial statements. These usually contain crucial information for analysts and investors and should never be ignored.
Five-year financial summary—condensed P&L/balance sheet figures for the five years to date (sometimes ten).
Shareholder information—gives details like the registered office, brokers, lawyers, shareholder registrars, and meeting dates; and reports dividend payments for the year.
The contents of an annual report vary in their importance, so although you could read it from cover to cover, you may prefer to focus on the figures themselves, in which the significant facts are contained.
The best place to begin reading is the Auditors' report—more specifically, the last paragraph. Here, the auditors give their opinion about whether the financial statements are a reliable indication of the company's position. If not, their report is said to be "qualified"—which means they have reservations about the accuracy of the picture presented. Qualifications range in gravity from a straightforward disagreement about how to account for something, to a belief that the company has made serious errors, resulting in a report that is neither true nor fair.
The five-year review is a good place to go next. You'll get an overview of the company's financial history, and how things like earnings per share (EPS), dividends, debt and stockholders' funds are changing. Look for patterns, how figures have increased or decreased, how steady they've been—anything that enables you to assess the company's performance over the years.
Depending on why you are interested in this company, the information you gather will inform your decisions in different ways. For example, if you're considering buying shares, you might want to see evidence of steady growth. Or if you're considering a buy-out, you might be more encouraged by a decline in the company's strength.
Read the reports from the Chair and the C.E.O. to pick up on their view of the company's performance (bullish or bearish? confident or cautious?). Always bear in mind that they're likely to present things in a favorable light.
The financial statements (and accompanying notes) form the heart of the report. Footnotes are rarely incidental, so make sure you read them carefully. Although the statements may be a bit daunting in their detail, they are at least required by law to follow standard reporting practice. This means there is less scope for concealing anything detrimental to the company, and that the annual reports of different companies are easier to compare.
By all means read the directors' analyses, and the attractively produced, glossy opening pages. But be skeptical about it, and remember that the hard facts are contained in the figures; not in the persuasive copy or the beautiful photographs. They can give a false view of the company's true performance, although they're much more approachable to most people than the dry data of financial statements.
U.S. Securities and Exchange Commission: www.sec.gov
Financial Accounting Standards Board: www.fasb.org