How To Read Annual Report Of A Company?

What is an 'Annual Report'?




An Annual Report (AR) in general is an announcement that organizations (companies) must provide annually, to shareholders and the interested public, to describe their financial conditions and operations.

It is published by the end of the Financial Year, and all the data made available in the annual report is dated 31st March. 

The AR is usually available on the company’s website as a downloadable document or one can contact the company to get a hard copy of the same, unlike the old times.

Since the annual report is published by the company, whatever is mentioned in the AR is assumed to be true in the best of knowledge. 

Hence, any misrepresentation of facts in the annual report can be held against the company. 

But how can someone trust the AR completely?

To give you an outlook, AR contains all the prime documents signed and sealed. Apart from this, it contains the auditor’s certificates which certifying the sanctity of the financial data included in the annual report. 



And hence one can blindly trust the facts in the Annual Report! 

But what was the need for an ‘Annual Report’?

All thanks to the stock market crash of 1929 that the annual report became a regular component of corporate financial reporting. 



Most popularly remembered for panic selling starting with the advent of the ‘Great Depression’, during this phase largest falls where witnessed in the following two years.

In fact, the Dow Jones Industrial Average (DJIA) hit the bottom by almost 89% from its peak in 1929, making it the biggest bear market in Wall Street’s history.

The main intention of AR is to provide public disclosure of a company's corporate activities over the past year. The report is typically issued to shareholders and other stakeholders who use it to evaluate the firm's financial performance.

Typically, an annual report will contain the following sections: 

  • General corporate information
  • Operating and financial highlights
  • Letter to the shareholders from the CEO
  • Narrative text, graphics, and photos
  • Management's discussion and analysis (MD&A)
  • Financial statements, including the balance sheet, income statement, and cash flow statement
  • Notes to the financial statements
  • Auditor's report
  • Summary of financial data
  • Accounting policies

Remember the information is more reliable if we get it to get it directly from the annual report. 

But why would the media website manipulate or misrepresent the company information?

Well, they may not do it on purpose but maybe due to better representation and understanding to contemplate data. For instance, the company may like to include ‘depreciation’ on the expense side of P&L, but the media website may like to include it under a separate header. While this would not impact the overall numbers, it does interrupt the overall sequencing of data.

Now that we understood all the basics of an AR let’s proceed.

On an average an AR consists of roughly 150 pages report, I have seen AR of a company as low as 70 pages and as maximum as 300 pages. With so much information on board, it is very unlikely that one would go by each page.

Summarizing we need to act smart! 



What to look for in an Annual Report?

The annual report has many sections that contain useful information about the company.

One has to be careful while going through the annual report as there is a very thin line between the facts presented by the company and the marketing content that the company wants you to read.

Let us briefly go through the various sections of an annual report and understand what the company is trying to communicate in the AR.

For the sake of illustration, I have taken the Annual Report of Hindustan Uniliver, belonging to Financial Year 2018-2019. As you may know, Hindustan Uniliver is a leading brand in Fast Moving Consumer Goods. You can download HUL’s FY AR from here

Please remember, the objective of this chapter is to give you a brief understanding of how to read an annual report.

Running through each and every page of an AR is not practical; however, I would like to share some insights into how I would personally read through an AR.

And interestingly there is good news for you, this will help you understand what kind of information is required and what information can simply be ignored.

HAPPY! 



No, VERY HAPPY!


For a better understanding, I would urge you to download the Annual Report of HUL and go through it simultaneously as we progress through this chapter.

Note, no two annual reports are the same; they are all made to suit the company’s requirement keeping in mind the industry and sector they operate in.

However, some of the sections in the annual report are common across annual reports.

More of less annual report contains the following sections:

  • Financial Highlights
  • The Management Statement
  • Management Discussion & Analysis
  • 10year Financial highlights
  • Corporate Information
  • Director’s Report
  • Report on Corporate governance
  • Financial Section, and
  • Notice

The first section in HUL’s AR is the ‘Chairman’s Statement’.

I spend time going through this section. It gives you an understanding of what the management of the company has to say about their business and the industry in general.

As a potential investor in the company, every word mentioned in these sections is important.

In fact, some of the details related to the ‘Qualitative aspects’ (as discussed in chapter 2), can be found in this section of the AR. 

But why is there a necessity to read the Chairman’s Statement?

The investor gets a perspective of how the person sitting right on top is thinking about his business. The content here is usually broad-based and gives a sense of how the business is positioned.

When I read through this section, I look at how realistic the management is. I am very keen to see if the company’s management has its feet on the ground.

I also observe if they are transparent on discussing details on what went right and what went wrong for the business.

One example that I explicitly remember was reading through the chairman’s message of a well-established manufacturing company.

In his message, the chairman was talking about revenue growth of nearly 10%, however, the historical revenue numbers suggested that the company’s revenue was growing at a rate of 4-5%.

Clearly, in this context, the growth rate of 10% seemed like a celestial move. This also indicated to me that the man on top may not really be in sync with ground reality and hence I decided not to invest in the company.

Retrospectively when I look back at my decision not to invest, it was probably the right decision.

Here is the snapshot of HUL; I have highlighted a small part that I think is interesting. I would encourage you to read through the entire message in the Annual Report.

The second section in HUL’s AR is the Financial Highlights. Financial Highlights contains a panoramic view of how the financials of the company looks for the year gone by. The information in this section can be in the form of a table or a graphical display of data. This section of the annual report generally does a multi-year comparison of the operating and business metrics.

Here is a snapshot of HUL’s Financial Highlights; 



The details that you see in the Financial Highlights section are basically an extract from the company’s financial statement. Along with the extracts, the company can also include a few financial ratios, which are calculated by the company itself. 

I look through this section with my eyes wide open with a bull’s eye view to get an overall idea, but I do not like to spend too much time on it. 

The reason for looking at this section briefly is that, I would anyway calculate these and many other ratios myself and while I do so, I would gain greater clarity on the company and its numbers. 

Needless to say, over the next few chapters we will understand how to read and understand the financial statements of the company and also how to calculate the financial ratios. 

So RELAX! 

Psst … do you what is the best part of the whole AR? 

The Report of course! 

The front part of the report contains an impressive combination of graphics, photos, and an accompanying narrative, It seems as if the company’s chronicle is being written in a storyline format. 



 Moving ahead, the next section is the ‘Management Discussion & Analysis’ or ‘MD&A’. This according to me is perhaps one of the most important sections in the whole of AR. The most standard way for any company to start this section is by talking about the macro trends in the economy. They discuss the overall economic activity of the country and the business sentiment across the corporate world. If the company has high exposure to exports, they even talk about global economic and business sentiment. 




Following this, the companies usually talk about the trends in the industry and what they expect for the year ahead. This is an important section as we can understand what the company perceives as threats and opportunities in the industry. Most importantly I read through this, and also compare it with its peers to understand if the company has an advantage over its peers.

For example, if HUL is a company of interest to me, I would read through this part of the AR and also would read through what Nestle or Dabur or ITC has to say in their AR.

Remember until this point the discussion in the Management Discussion & Analysis is broad-based and generic (global economy, domestic economy, and industry trends).

However, going forward, the company would discuss various aspects related to its business. It talks about how the business had performed across various divisions; how did it fare in comparison to the previous year etc. The company in fact gives out specific numbers in this section. 




In some AR's there are details about strategies mentioned.




In some AR's, Value Creation model is highlighted.

After discussing these in ‘Management Discussion & Analysis’ the annual report includes a series of other reports such as – Human Resources report, R&D report, Technology report, etc.

Each of these reports is important in the context of the industry the company operates in. For example, if I am reading through a manufacturing company annual report, I would be particularly interested in the human resources report to understand if the company has any labor issues. If there are serious signs of labor issues then it could potentially lead to the factory being shut down, which is not good for the company’s shareholders. 

Financial Statements

Finally, the last section of the AR contains the financial statements of the company. As you would agree, the financial statements are perhaps one of the most important aspects of an Annual Report.

There are three financial statements that the company will present namely:

1. The Profit and Loss statement

2. The Balance Sheet and

3. The Cash flow statement

We will understand each of these statements in detail over the next few chapters.

However, at this stage, it is important to understand that the financial statements come in two forms.

1. Standalone financial statement or simply standalone numbers and

2. Consolidated financial statement or simply consolidated numbers

To understand the difference between standalone and consolidated numbers, we need to understand the structure of a company. 




Typically, a well-established company has many subsidiaries. These companies also act as a holding company for several other well-established companies. To help you understand this better, I have taken the example of Reliance Industries Limited’s shareholding structure. You can find the same in Jio’s annual report. 





As you can see in the above shareholding structure:

1. Reliance Industries Limited holds a 90% stake in Jio Platforms Limited. Hence Reliance Industries Limited is the ‘Holding company’ or the ‘Promoter’ of Jio Platform Limited.

2. The balance 9.99% of shares of Jio Platform is held by Public and other Investments/Financial institutions

3. This means Reliance Industries fully owns the Jio platform, and Jio Platform owns further Reliance Jio Infocomm Limited and other investments.

4. Further, Jio Platform fully owns (100% shareholding) another company called ‘Reliance Jio Infocomm Limited’.

Keeping the above in perspective, think about this hypothetical situation. Assume, for the financial year 2013, Jio Platform Limited makes a loss of Rs.1000 Crs and Reliance Jio Infocomm Limited, its 100% subsidiary makes a profit of Rs.700 Crs.

What do you would be the overall profitability of Jio Platform Limited?

Well, this is quite simple – Jio Platform on its own made a loss of Rs.1000 Crs, but its subsidiary Reliance Jio Infocomm Limited made a profit of Rs.700 Crs, hence the overall P&L of Jio Platform is (Rs.1000 Crs) + Rs.700 Crs = (Rs.300 Crs).

Thanks to its subsidiary, Jio Platform s loss is reduced to Rs.300 Crs as opposed to a massive loss of Rs.1000 Crs. Another way to look at it is, Jio Platform on a standalone basis made a loss of Rs.1000 Crs, but on a consolidated basis made a loss of Rs.300 Crs.

Hence, Standalone Financial statements represent the standalone numbers/ financials of the company itself and do not include the financials of its subsidiaries. However, the consolidated numbers include the companies (i.e. Standalone financials) and its subsidiary's financial statements.

I personally prefer to look through the consolidated financial statements as it gives a better representation of the company’s financial position. 

Schedules

When the company reports its financial statements, they usually report the full statement in the beginning and then follow it up with a detailed explanation.

Have a look at the snapshot of one of HUL’s financial statement (balance sheet):

Asset Side:
                         

Liability Side:


Each particular in the financial statement is referred to as the line item.

If you notice, there is a note number associated with share capital. These are called the ‘Schedules’ related to the financial statement. Looking into the above statement, HUL states that the share capital stands at Rs.216 Crs (or Rs.216 Million).

As an investor, I obviously would be interested to know how HUL arrived at Rs.216 Crs as their share capital. To figure this out, one needs to look into the associated schedule (note number 17). Please look at the snapshot below:


Considering you a newbie to financial statements, jargon’s like share capital make not make much sense.

However, the financial statements are extremely simple to understand, and over the next few chapters, you will understand how to read the financial statements and make sense of it. But for now, do remember that the main financial statement gives you the summary and the associated schedules give the details on each line item.

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