How to read the Annual Report of any Company?

An annual report carries a lot of important information that requires detailed analysis to make proper financial decisions as an investor. What are the important areas on which attention should be given? How to analyze the figures in the Financial Statement?

What is an Annual Report?

Annual Report is the yearly report given by a company stating its vision, plans, financial results, board report, and other important information. It is generally dated to 31st March. The AR is published on the company's official website and is provided as a PDF document and the shareholders are provided with the hard copy of the same.

The AR is a public document that contains an auditor's certification that certifies the sanctity of the report. While there are other media sites that claim to provide true data about the company, but investors should avoid using these sources. The AR downloaded from the company's own website is of utmost sanctity and maximum reliance should be placed on it for authentic data.

For every investor, it is a very tough decision as to in which company investment is to be made. He has to look into the working of the company and the people at the helm if the affairs to take a rational decision about the future prospects. The length of the AR sometimes demotivates a person from going through the whole of it. However, the importance of AR cannot be diminished, hence, the focus should be given to focus on the most important aspects and take a wise decision about the future of the company.

What makes AR boring?

Problems with AR:

• Lengthy
• Jargon heavy
• A lot of advertisement
• Useful content gets lost

What mistakes do people make?

• No attention to details
• Miss the important parts
• See the numbers and take it as the only aspect to make a decision about the company
• Do not give importance to managerial aspects

Why is AR important?

• Considered as the official statement of the company
• Gives a sense of management sentiments
• The cleanest source of data
• A most reliable source of information
• Contains all the aspects which need to be considered in one place

What should you focus on- the 80/20 rule!

Considering the length of the AR, it is not possible to go through the whole report. Also, 80% of the information is not important for us and does not affect our decision-making process. Therefore, it is very important to identify the remaining 20% and spend time analyzing this information. The most important aspects of AR are:

• Initial page
• Chairman's letter
• Board's report
• Shareholding information
• Report on Corporate Governance
• Management Discussion & Analysis
• Consolidated Financial Statement

Let us start understanding step by step where should we focus our attention

Initial page:

• Management Names: You must be wondering how is this important for us? The answer is quite simple, it is always advisable to know what sort of people are handling the company and a little bit about their background and reputation. The reputation of the company is a reflection of the people managing it.
• Family control: This is a very important aspect as the future leaders of the company depend solely on this aspect. If there is too much family control in the company then somewhere democracy loses its importance. On the other hand, companies like TATA group are known for their family name and background. Thus, family goodwill is a very important key factor.
• CFO: The Chief Financial Officer of the company which technically has the most important decisions to make i.e Financial decisions. Therefore, the importance of a CFO can be judged without saying. The mindset of the CFO will have a direct impact on how many risks the company is taking, what new ventures companies will undertake, what sectors will favor the company, etc.
• Auditors: Auditors of the company acts like watchdog who looks carefully inside the company to make sure nothing illegal or wrong is happening there. The more reliability investors can put on the auditors, the more confidence they will have in the company. This is because a good auditor ensures that everything is in place and reduces the chances of malpractices.
• Bankers: After many scams in India, like Satyam, Kingfisher, PNB, etc. it is very important to know whether the company is engaged with reliable bankers and is backed with appropriate hypothecation and securities. Engaging in trade with reputed banks increases the confidence of people as they feel secure about their money.

Chairman's Letter:

• High-level overview: Do a quick overview of what the chairman is trying to communicate to the shareholders. It is very important to evaluate with what truthfulness the chairman is communicating, as it speaks a lot about the honest culture prevalent in the company and whether the company believes in hiding its mistakes.
• Industry overview: Sometimes, the chairman talks about the industry in which the company is functioning, whether it's seasonal in nature or whether there is any new government policy affecting the company drastically
• One line business insights: Many a time, companies have diverse business lines and while some may be working smoothly others may have trouble surviving. The Chairman's letter addresses such concerns which should be carefully read.

Board's Report:

• Subsidiary information: When the company holds the majority of the voting power or shares of the company, then that company becomes a subsidiary of the main company. It is very important to know that the company holds what sort of companies to analyze the investment pattern of the company. Also, having too many subsidiary companies is not good.
• Management's salary: The amount of expenditure the company is making in paying the directors should be carefully studied. This is because we must understand if all the profits are diverted towards the management itself. If yes, we should carefully analyze if there is an adequate share of profit for distribution to the shareholders. The company should be keen to fulfill the expectations of its shareholders and not merely fill the pockets of people engaged in the management of the company.
• Related Party transactions: It is upon the board to give consent to all RPT and thus the rationality of such transactions should be judged. Too many RPT may indicate red-tapism in the company which may adversely affect the company in near future.

Share Holding:

• In subsidiaries: The number of Shares held in the subsidiaries. It is important because if the subsidiary is a risky business then it may severely impact the main company's working
• By Promoters: Another important aspect is to understand how many shares are held by the promoters of the company, to know what is the role of promoters.
• By NRI: It is important to note if shares are held by NRIs because many a time this may result in plowing back of profits and there are also government norms for the same. Also, care should be taken about Foreign Investment in the company on the whole.
• By Mutual Funds: If it is not a big company then chances are that there would not be much mutual fund investment. However, one more aspect can be to check that since no Mutual Fund has invested does it makes the company riskier?

Report on Corporate Governance:

• Board composition and other directorship: The composition of the board should be carefully reviewed to analyze if the majority of the decisions are taken by only a few. It is not a good practice as decisions are made merely on the basis of relationships and not on merits.
• Salaries paid to the board: The amount of expenditure the company is making in paying the directors should be carefully studied. This is because we must understand if all the profits are diverted towards the management itself. If yes, we should carefully analyze if there is an adequate share of profit for distribution to the shareholders. The company should be keen to fulfill the expectations of its shareholders and not merely fill the pockets of people engaged in the management of the company.
• Disclosures: The board is liable to make certain disclosures that are very important like related party transactions, corporate social responsibility, IPO expenditure made, etc. All these should be carefully analyzed so as to judge if appropriate disclosures are made or not.

Management Discussion and Analysis:

• Overview of Industry: This is the most important section of the AR. There is an overview of how well the industry is functioning, what challenges they have to face, and if there are any advantages for the functioning as a whole. It should be noted as to where the company stands in the industry and its share of profit.
• Business Performance:
• Capacity utilization: We must see if the company is fulfilling its production capacity or not. In order to take advantage of economies of scale, full capitalization is important. It should be assessed if the company is working in the best possible way.
• Capex Plans: Capex plans refer to the Capital Expenditure which the company plans to incur in the near future. This is very vital for the future growth of the company as to where the company is planning to make its long-term investment, in which sector, and for how long.
• Sector-wise performance & Capex: Generally, companies function in more than one sector, thus, care should be given on sector-wise performance and capital expenditure. It will be a crucial decision for the company to judge which sector is most likely to generate profits in the long run.
• Business Risks: The company faces many business risks like economic risks, political risks, financial risks, etc. How a company addresses these risks and works needs to be evaluated to know about the viability of the company.

Consolidated Financial Statement:

• Balance Sheet: The Balance Sheet provides an idea about the whole financial position of the company along with its subsidiaries. The Assets and liabilities should be read carefully to evaluate if the company is not overburdened to meet its liabilities. The liquidity of the company should be ascertained along with the working capital availability. Other important ratios should also be analyzed.
• Profit & Loss account: This shows the actual profitability the company has made in the current year in comparison with last year. Many people consider it as the only aspect that is to be covered, however, this is not true. It is definitely an important aspect but not the only aspect. Also, whether the company is making excessive expenditure needs to be analyzed.
• Cash flow statement: The net cash inflow and outflow show the operations and transactions the company has indulged into. The cash flow statement speaks a lot about the company's investments, financing activities, and also how well the operations are working.

No doubt, the Standalone financial statement is very important, however, Consolidated Financial statements provide a wider view and therefore, are carefully studied.

Conclusion:

As an investor AR are very important and proper time should be given to read it. While you can read the first few points like the initial page, Chairman's letter, and report on Corporate governance in 5-10mins each topic, the Management discussion, and Consolidated Financial statement should be given around half an hour each to analyze. Thus, around 1.5 hours should be allocated to read it carefully and decide accordingly.