How and why to read an Annual Report

When we buy shares of a company, we become part owners of that business. But we as owners do not participate in the day-to-day activities of the business. That is the job of a management team that may or may not be part owners like you and the other shareholders. Here, the management always has a better idea of what’s going on in the business, and the shareholders i.e., the owners can be kept in the dark. This can result in a Principal-Agent conflict. Better disclosure norms in addition to management’s integrity prevent this conflict to a certain extent. An annual report plays a big role in this.

• The Annual Report (AR) of a company is an official communication from the company to its investors: A listed company generally issues an investor presentation every quarter or twice a year and many companies conduct a conference call for the investors to ask questions to the management. However, conducting such calls is only advisable by the regulation and not a mandatory requirement. On the other hand, issuing an Annual Report is a requirement for a listed company.
• The AR is the right source to get information about the company; hence AR should be the first choice for the investor to source company-related information: If a company publishes a quarterly presentation, it would contain time-specific content, i.e., information about that specific quarter. However, an AR generally includes a company’s history, recent developments, and plans.
• The AR contains many sections, with each section highlighting a certain aspect of the business: Apart from general information about the company, an AR always has the Chairman’s and/or CEO’s message, a management discussion and analysis (MD&A) section, and the company’s standalone and consolidated statement of accounts.
• The AR is also the best source to get information related to the qualitative aspects of the company: The MD&A section is one of the most important sections in the AR. It has the management’s perspective on the country’s overall economy, their outlook on the industry they operate in for the year gone by (what went right and what went wrong), and what they foresee for the year ahead.
• The AR contains three financial statements – Profit & Loss Statement, Balance Sheet, and Cash Flow statement. There’s a famous saying that goes, “Revenue is vanity, profit is sanity but cash is the only reality”. It suggests that revenue and profit figures can be manipulated but it is extremely difficult to tamper with the cash flow statement. Yes, basic accounting knowledge is required to analyze financial statements.
• The standalone statement contains the financial numbers of only the company into consideration. However, the consolidated numbers contain the company and its subsidiaries’ financial numbers. It is important to look at both standalone and consolidated numbers especially when the subsidiaries are partly owned by the parent entity.

Does this short article cover everything that has got to do with reading annual reports? Absolutely not. But it might help a beginner to skim through an AR and determine, from the sea of information available, what is material and what is noise – separate the wheat from the chaff.

Are you reading an AR for the first time? We suggest choosing a company about which you have some domain knowledge. For example, a pharmaceutical company if you’re a doctor, a tech company if you’re from that field, or an automobile manufacturer if you have a knack for it.

Finally, reading an annual report is an art and one gets better at it with practice.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”