Beginner’s Guide to Fundamental Analysis: How to read a company’s Annual Report
The Annual Report (AR) is the most important report a company publishes to project an image of a well-managed organization and profitable business entity. The AR is where you can obtain valuable information about a company of interest. The report gives full disclosure and honest revelation of the institution’s overall performance in a given financial year or accounting period. Investors, creditors, and market analysts scrutinise the company based on its contents, which are assumed to be truthful and realistic.
However, it takes some skill to read and understand the annual report. The company spends painstaking energies to prepare and craft the final report. The purpose of the annual report is to make known the company facts to shareholders and investors in particular. While the information may be comprehensive, many fail to read the annual report effectively.
The Essential Contents of the Annual Report
Every page in every section is significant whether they contain messages, figures, statistics, charts, and non-financial information. The company is conveying and sending something across. There are key issues they don’t want you to miss. Hence, you need to know exactly what these issues are.
Excerpts shown in this article were taken from the published 2016 Annual Report of Wilmar International Limited.
The typical annual report opens with an introduction section that provides a brief business overview and industry outlook. Big corporate names, mainly publicly listed companies, include the statements and messages of the Chairman, Chief Executive Officer, or the Directors. The inclusion of the company’s top brass would lend credence, add weight and impress upon the reader. In short, it’s putting the best foot forward while setting the tone for what should be an engaging read.
The mission and vision statements, as well as the core values of the company, would always be included in the intro section. It’s a way to accentuate that the activities they have accomplished for the year are consistent with those objectives and principles.
Compliance with the Code of Corporate Governance
In Singapore, publicly listed companies are mandated by the Singapore Exchange Listing Rules to make known their corporate governance practices and justify the deviations, if there are any, from the Code of Corporate Governance issued by the Monetary Authority of Singapore (MAS).
In the annual report, this section would show if the company is complying with the MAS-issued code. The composition of the people behind the company’s operations, particularly the members of the Board of Directors, President or Chief Executive Officer are presented. This is material because they are the people accountable to the shareholders and the investing public.
To add to the integrity of the AR, the report of a reputable and independent auditing firm is included. The Auditor’s Report affirms the accuracy of all financial data presented.
The Financial Statements
The pillar of a company’s annual report is a set of quantitative reports known as the financial statements. In this section, you will see the Balance Sheet, Income Statement (P&L), Cash Flow Statement, and the Notes to the Financial Statements. All the details regarding the sources, utilisation, management, and flow of funds are presented in these statements.
Balance Sheet – Assets & Liabilities
The Balance Sheet is a summary of the company’s financial position and condition for the year in focus. It’s a statement that is broken down into three segments – assets, liabilities, and shareholders’ equity.
This statement shows what the company owns (assets) and what the company owes (liabilities + shareholders’ equity). By intuition, the asset and liabilities should balance out in an equation, giving rise to the term balance sheet.
The asset side is composed of the cash items and non-cash items. The cash items are those that can be converted to cash while the non-cash items are long-term assets which are not convertible to cash. You will notice that the items listed under assets are presented in the order of their liquidity or ease of conversion to cash.
Income Statement – Profit & Loss
The Income Statement or the Profit & Loss Statement is where you’ll see if the company is making or losing money. When reviewing the P&L statement, you’ll get an actual reading or measure of the company’s financial performance.
There’s always a side-by-side column of the current and previous year or years. You’ll be able to assess whether the business has improved, weakened or remained stagnant in the areas of revenues, expenses, and more importantly, net income or profits.
Cash Flow Statement – Utilization of Funds
You will see from the Cash Flow Statement how the company generates funds or from where the funds were sourced. The statement also shows how these funds were utilized or where they were allocated or expensed out. You can determine from the cash inflows and outflows the liquidity or solvency of the company.
Notes to the Financial Statements – Elaboration of Financial Data
You may find it difficult to understand the figures presented in the financial statements without the Notes to the Financial Statements. In order to have a better appreciation, there are accompanying notes to explain these numbers.
The ‘notes’ inform the readers the accounting policies implemented by the company in the preparation of the financial statements. This section would also elaborate other critical details such as business risks, company valuation, taxes, borrowings, and third-party transactions. The Notes to the Financial Statements are intended to dispel all doubts regarding the company’s operations. In effect, all the financing activities were done in good faith and are above board.
Other Relevant Non-Financial Information
The financial data contained in the AR are supported by relevant non-financial information. You’ll be overwhelmed at first by the complex numbers. But once these you’ve read the supporting materials, you can reconcile those figures with the non-financial information.
Apart from the numbers, an AR provides a comprehensive review of the company’s operations. The information would include the initiatives, product programs, capital expenditures, among others that helped the company boost its growth and stability.
Market / Industry Conditions
There is also information on the business environment on the market or industry to which the company operates. The company’s achievements are highlighted and what strategies would be undertaken in the future to strengthen competitiveness and counter the threats in the sector. Growth opportunities and revenue potential are identified as well.
An annual report is a useful guide for investors when assessing the performance of a company. The exhaustive report highlights the accomplishments or major feats during the accounting period as well as the steps that would be carried out in the near future.
In this age of digital communications technology, you need not obtain the physical print version of the AR. Online versions are available so it’s more convenient to check on a company’s track record. Each time you read an annual report, remain skeptical and vigilant.