How to read an Annual Report

How you read an annual report depends upon your purpose. As an investor, your purpose may be to assess profitability, growth, stability, dividends, potential problems, risks or other factors, which may affect your investment in that company.

The annual report provides a convenient way to monitor the progress of a company. If you own shares in the company you should receive a copy of their annual report in the mail from the company.

Annual reports are a corporate “work of art” and should not be read like a normal book. There is no need to read the report cover to cover. The first pages are a colorful, non-technical overview of the company’s objectives and how well it’s meeting them. The pages in the back are for number crunching and heavy-duty research.

Receiving and reading annual reports together year-to-year creates a kind of timeline for the company. You can learn a lot by reading about how the company changed their business model or carried out their desired plans from one year to the next.

There are nine sections in most annual reports. Not all reports will have all the sections or the same type and amount of information. Here are the sections, what you’ll find in each, and questions you should ask yourself:

* Letter from the Chairman: Should cover changing conditions, previous objectives met or missed and upcoming objectives, and actions taken or not to be taken.

*Ten Year Summary of Financial Figures: Is this included? Have revenues and profits increased each year?

* Management Discussion and Analysis: Is it a clear discussion of significant financial trends over the past few years? How candid and accurate is it?

* Subsidiaries, Brands and Addresses: Where is their headquarters? Is it clear what lines? Brand names the company has and what their overseas distribution network is?

* List of Directors and Officers: How many directors? Are the directors well known and respected? Are there an unusual number of directors (5 to 12 is typical)?

* Financial Charts: Financial information over a period of years in graphical representation.

Financial Statements

Most of the information you’ll be concerned with in the annual report is located in the financial statements (the balance sheets, the cash flow statements, and the income statements), which are discussed in detail in the Financial Statements section, Notes to Financial Statements.

* Stock Price History: General trend of price over time. Up or down?

* Financial Statements: This is the most important section of the annual report. According to the CSE Listing Rules, a listed company shall prepare and circulate the Annual Report to the Exchange and to all Shareholders of quoted securities before the expiry of 06 months from the close of the financial year.

These statements provide key information about the performance and financial health of the company.

The following are the different financial statements that are disclosed in the annual report, Statement of Income, Balance Sheet and Statement of Cash Flows.

Income Statements

The income statement (sometimes called the profit-and-loss statement or P&L) shows the revenue, expenses and profit for the company during the past year. You can use the income statement to figure out cash flow, profit margins, and other financial metrics for the business.

Most importantly, the income statement contains the proverbial bottom line: profits.

The statements are audited by outside firms, however, so there should be footnotes or other markers whenever anything deviates from standard accounting practices. The following list will teach you how to read an income statement and use the information from them to make some simple calculations regarding the firm’s operations.

* Revenues: The revenue section will tell you how much profit the company took in for a specified period of time. Sometimes companies will break down revenues according to business sector or geographic region, but usually there will just be one number. Some companies, especially retailers and manufacturers, use the term sales instead of revenues, but it’s the same idea.

* Expenses: The expense section will show you how the company spent its money.

Companies spend their money on a lot of different activities, so this section is usually broken down into specific sub-sections. You might see expenses such as the following:

* Cost of Sales: This number includes expenses directly associated with creating revenue, such as labor and materials.

* Operating Expenses: This number includes activities such as marketing, research and development, and administration. It usually also includes depreciation expenses and any special non-recurring charges.

* Interest Expenses: This figure includes all the interest the company paid out on its bonds (if any) and/or long-term debt.

* Taxes: The amount of money paid as taxes by the firm.

* Extraordinary Expenses: This figure shows any unusual or one-time charges that the firm must pay (e.g. a lawsuit settlement).

* Profit: The profit section of the income report is the part to which investors pay the most attention. It shows whether the company made money or lost money. It usually includes these specific sections:

* Net Income: This is the company’s bottom-line profit after all expenses and revenues have been accounted for. If this number is positive, then the company turned a profit for the period. If it’s negative, then the company suffered a loss.

* Margins: You can find out how much a company is really earning from its revenues on the income sheet by calculating its margins, which are earnings expressed as a percentage of sales. Here are a few margins that you might find useful:

Gross Margins will tell you how much a company earns taking into consideration the costs that it incurs for producing its products and/or services.

In other words, gross margin is equal to gross income divided by net sales, and is expressed as a percentage. Gross margin is a good indication of how profitable a company is at the most fundamental level.

Companies with high gross margins will have a lot of money left over to spend on other business operations, such as research and development or marketing.

Net Margins are similar to gross margins, except they take into account all of the expenses associated with the business, including marketing expenses, administrative expenses, etc. (so it is equal to net income divided by net sales).

Net margins provide an overall picture for the company; this is what shareholders and investors usually watch most carefully.

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