Master Class 8: 7 Things to look for in an Annual Report

1 Sep 2020  Read 789 Views

We all love James Bond. When it comes to the market, we wish we would be one because understanding the company is no child's play. But if we said that there is an easy way for it, would you believe it? A way that does require you to go for missions or kill a bunch of people for it. Yes, you can find it all by reading the annual reports of the company. From strengths to weaknesses, the financial statement has it all. But the trickiest part is how you read it. Are you ready to find out? Then read further.

What is an Annual report?

The annual report is like the portal, which will tell you inside-out about the company you are about to invest in. It is usually published at the end of the financial year to attract potential investors. As a reliable source, it will help you analyze a company effectively. Hence, reading the annual report is vital for an investor looking for good returns. You can find the annual reports on the company's website or simply go to Ticker Screener

Source: Stock Analysis by Ticker

However, lacking the knowledge as to how to read one can make your task tougher. In fact, one must know where to look and what details to look for in an annual report to arrive at a conclusion with respect to the company's status. If you are looking to learn and master the art of reading the annual report, then you are in the right place.  

We will see in detail as to how one can make a company analysis by reading the annual reports appropriately. 7 crucial things you must pause and pay attention to while skimming through the annual reports are as follows, 

Financial highlights

Financial Highlights is basically an extract from the company's financial statements, which include profit and loss statements, cash flow statement, and balance sheets. This category helps to have a quick glance as it summarises the company's key financial figures without demanding you to jump into the details of it. In short, the tedious task of finding out crucial financial achievements by looking through the profit and loss statement or the balance sheet is simplified. You can also find out how the company has progressed in comparison with the previous year. For instance: from the picture below, you can find that Zydus healthcare ltd has a net profit growth of approximately 21%, the EBITDA has grown by 16%, and so on. 

Source: Zydus Wellness

Products status

This part of the annual report will project the market share of various products owned by the company and the line of products that are owned by the company. Those products, which have been newly launched into the market, will also be mentioned here. You can give a quick glance through this section. 

Source: Zydus Wellness

Management letter

No one can give you the right outlook of the company than the board themselves. So even if you skip the other sections of the annual report, it is mandatory that you read this section carefully. The management letter is usually the director's or CEO's or Chairman's letter. The letter will tell why some decisions were taken, what is to be expected from the decisions, and so on. You can understand the operations and proceedings of the company from a managerial point of view. An investor must pay close attention to the tone of the letter as well. Figuring out whether the tone is doubtful or positive or negative will help you picture the company's future prospects. 

Source: Zydus Wellness

Have you read our previous Master Class: Analysis of Banking stocks and the importance of CASA Ratio, NPA, CAR ?

Management discussion and analysis

Here comes the interesting part. As the name suggests, this segment will break the entire company and the environment it operates in for you. Everything from the trends, strategies, and risk factors associated can be located here. If you are keen on knowing about all macro and micro concepts that might affect your investment, then reading of this section is required. It discusses various aspects pertaining to the economy and market conditions. If your company is more inclined towards the domestic market, then you will find an elaborated analysis of the domestic market. This section also includes risks associated with the company. An investor should look out for any unusual risks that would have an impact on their investment. It might be labor issues, patent fights, frequent shutdowns, etc. 

Source: Zydus Wellness

Report on corporate governance

A company is as good as it's leaders. Because an efficient and smart management chain can turn stones into diamonds. Do you want to know who operates the company? Then this section is to look for information relating to the background of independent directors, their salary, the composition of directors, remuneration, work experience, etc. can be found here. So give a quick read-through, but avoid spending too much time here. 

Financial statements

Now let's speak some money. Shall we? This is the most important section of the annual reports as it tells you everything as to how the firm is handling its finance. Financial statements are financial records maintained by a company that records everything from assets, liabilities, business operations, cash flows, profits, and losses, etc. A company's financial statements include the profit and loss statement, the balance sheet, and the cash flows statement. A good analysis of these statements will help you figure out the financial stand of the company. You should have a keen eye while scanning through this section to spot anything that is odd or likely to trigger doubt. In short, the financial statements are like a mirror that reflects the financial health of the company. The financial statement can either be in the form of a standalone statement or a consolidated financial statement. A standalone statement projects data of the company alone and does not include its subsidiaries. On the other hand, the consolidated statement will include every aspect of the company and gives a compressed data. This section contains three major parts. They are, 

  • Profit and loss statement.
  • Cash flow statement and,
  • Balance sheet.

Further, it is possible for a company to have good sales or revenue projections and still make a loss. Hence, one should compare the profit and loss statement of a company with its cash flow statement. The balance sheet of a company will help in figuring out how much was invested, borrowings, liabilities, loans repaid, etc. 

Source: Zydus Wellness

Notes to accounts

Reading this part is essential to get clarity over the things mentioned in the financial statements. It clearly explains the items cited in the financial statements. Things that cannot be adjusted or shrunk into the financial statements are mentioned here. Further, any shift in the accounting policy or accounting methods will also be mentioned. You can also acquire details regarding the various parties mentioned in the statements like debtors, creditors, etc. Say the company had made some allocation towards employee benefits. You can get to know what they are in this section. 

To conclude

Knowing the company well is essential to make proper investment and to locate potential cash cows. Reading the reports of the company will serve to be of great assistance in that process. Hence, if you are not a big fan of reading large reports, you can skip it. But following the above shortcuts and tips will help you navigate to the information required by helping you surpass a whole mountain of details, numbers, and data. So quickly run to the company you want and start analyzing it from scratch. And if you encounter any problem, then don't fail to click the link to know more YouTube. Finally, remember to have fun investing!

Check out our next blog series: How to analyze and value Banking Stocks - NIM and ROA

To read all Master Class series Click Here

About the Author: Varishika Dinesh | 70 Post(s)

Varishika is on the verge of successfully completing B.Com. Nothing excites her more than reading books and watching movies. Business, finance, economy? You have her attention.

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