The Hindu Business Line : Are you neck-deep in numbers?

GADGETS come with user's manual, software ships with help facility, research papers have ample footnotes, and there are commentaries for difficult poetry. However, much of company-speak is not accompanied by some help to understand.

Understanding Corporate Annual Reports, by Brian Stanko and Thomas Zeller, fills in that gap providing a `user's guide' to make sense of the fine print. The book from Wiley (www.wiley.com) is essentially about the US reporting, though there are enough inputs on how one can go about analysing past performance and examining the connection between corporate strategy and financial resources, thus going beyond "the glossy pictures and slick writing style prepared by public relations professionals".

Why are annual reports lengthy, difficult to read, and quite confusing? "Much of this can be attributed to today's complex working environment," note the authors. "Accounting and reporting rules can also add to the complexity of the report." But the real troublemaker that adds to actual complexity of financial reporting is the "positive spin" that the management gives financial performance, regardless of reality.

One of the pages that most readers miss is the carefully prepared `mission statement'. They are viewed as a strategic communication tool, say the authors. But some people confuse the words mission and vision. "An organisation's mission is what the organisation is and its reason for existence, whereas vision is a forward-looking view of what the organisation wants to become." At least one thing that can be common is that a management can lie about both.

MD&A, if you didn't know, is "management's discussion and analysis". The SEC requires the management to address three areas — capital resources, liquidity, and results of operations. With more attention being given to this portion of the annual report, MD&A has increased from seven pages to more than 12 pages, over the recent decade.

Balance sheet is seen as the grand finale to accounting, with assets and liabilities, providing information on the company's liquidity and solvency. But it has its shortcomings, says the book. "Account values within the balance sheet are not always measured according to the same rule."

Some are shown at historical cost, some at net realisable value. "Another limitation is that certain values are based on management's best estimates." Much mischief has occurred in this department: "To increase earnings, companies have extended the lives of assets, and to decrease earnings companies have shortened the lives of assets. This has led to what the SEC calls abusive earnings management."

Likewise, income statements too have limitations. Such as: There are varying methods of cost allocation. Management's intent can drive accounting. Accrual accounting, as a basis, can decrease net income. Also, net income ignores when future cash receipts tied to current revenues will be received and when future cash payments tied to current expenses will be paid.

The longest chapter of the book is on financial analysis where the authors present "one complete road map" and a comprehensive example (Home Depot) of how to evaluate and interpret the information found in the annual report. "The business press and finance analysts all have a certain bias," cautions the author. "Completing your own analysis enables you to reach your own conclusion."

A chapter on `emerging issues in financial reporting' talks about earnings management, pro forma reporting, and quantitative and qualitative disclosures. There could be more such, because, after all, financial reporting is not an exact science. But is it, as many believe, a mangled art, or painted prose?

BooksOfAccount@rediffmail.com

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