Importance of Annual Reports and How to Analysis One

In this blog we will be addressing how an annual report is to be analysed and what is to be kept in mind while going through the report.

What is an annual report?

Listed companies on stock exchange need to share their performance with the shareholders on a yearly basis as a mandatory requirement by SEBI. It contains various data on the company’s business but the main focus is on the financial performance of the company.

Companies usually put their annual reports in the Investors relation column on their websites and anyone can download and read it. But it is a very large document containing a lot of words, pictures and charts which can be overwhelming to read and understand. From the investors' point of view, we need to cherry-pick some of the heads which contain decisive information.

Company Profile

First you need to look at the company’s business and it fits under which industry as it will help to compare performance with companies in a similar domain. Besides that, you need to see who all are the clients of the company, what are their products, and the presence on the globe. In addition to that, you can look for other subsidiaries and how their business is interconnected. It will help you understand the company’s structure.

Risks in the company

After understanding the business and how the company generates its revenue you need to look at the risk involved, How the company has planned to mitigate these risks. For example, a company might rely on a third-party for distribution of its products or huge R&D investments may not materialize. Though risk can hamper the company’s performance but companies only take risk where they see opportunities which can deliver growth for the company.

Corporate Governance

This heading shows the internal management hierarchy, who is the chairman, C.E.O, board of directors. This is important to know because these people’s experience, competitive and leadership skills will help you access internal risk and reliability. Another thing you can look for is trends in their salaries and compare them to the revenues of the company.

Director’s Report

After knowing the board comes a report from the director which states past performance, some major decisions and future strategy considering the present scenario. It segregates revenue, profit and other important metrics by their respected products. besides that payment of dividend to shareholders, what company kept as retained earnings and changes in share capital like the issue of bonus and Buybacks are important segments in this report.

Management Discussion and Analysis

Another imperative descriptor in the annual report is MD&A, which states the performance of the preceding year, present financial condition and future road-map. Beginning from an overview of the country’s economic performance, current trends with a focus on the industry in which the company is operating and what they expect in near future. Next to that is the company’s operating results of different product segments with geographical breakdown. Further, you can look for any changes in accounting policies such as impairments of goodwill and tangible assets. In this report there are several points to look at and, investing time in this section will give you a very good understanding of overall business.

Financial Statements

Financial statements are the most heard-off item and are of supreme importance to understand a company. There are three basic statements-

a) Balance sheet - It provides the company’s financial position at a given point of time. And shows what the company owns called Assets and what the company owes to its external and internal investors called Liability and Equity respectively, it balances at the bottom to confirm the accounting equation (Assets= Liability + Equity).

b) Income Statement - This is also called the profit and loss statement as it shows the income to the business and expenses made by the business to arrive at Net profit over a period of time. On top there is revenue and thereafter expenses, losses, adjustment for tax and net profit at the bottom.

c) Cash Flow Statement - As the name suggests it shows the inflows and outflows of cash in the business over a period. There are three broad categories, cash from general operations of the company which comes under operating activity. Below that cash flow from investments made by the company called investing activity. And in bottom cash flow from financing sources of the company.

Notes to Accounts: They assist the reader to understand the changes in all three financial statements. One might leave this column but to understand how the company has arrived at the numbers, Notes to Accounts are very useful

The crux: - An Annual Report provides useful information regarding financial health of a company along with past achievements and future strategic prospects. You can identify red flags and growth opportunities by reading an annual report. We suggest that you should read the annual report before investing for the long term.