How to read an annual report

Bhavana Acharya
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An annual report helps you understand both the company and its industry.

Annual reports are coming thick and fast these days, but do you think they are just tomes of endless prattle about sales and profits? Well, if this has made you push reading annual reports to the bottom of your to-do list, here are the areas to focus on.

About the company

The more dressed-up of annual reports start off with ritzy pictures and write-ups on what the company does, or doesdifferently;recent initiatives undertaken which have paid off. It makes for quick reading.

But focus on the first important area the director’s report and management discussion and analysis (MDA). Here, you get detailed information on a company, its business segments and industry. Know zilch about the paints industry? Read up Asian Paints’ annual report. Hold stocks of Aditya Birla Nuvo but don’t exactly know the myriad businesses it is involved in? Read up the MDA. The sections explain what the company did in the past year, factors affecting the industry and how the company deals with it, impact of past and potential policy changes, what the company’s roadmap for the year ahead is, the threats it faces, opportunities it plans to exploit and so forth. At times, production figures, manufacturing capacity utilisation and basic ratio analyses are also included.

Details such as issue of foreign currency convertible bonds (FCCB) and global depository receipts, which are significantsince they could lead to equity expansion , is contained here. For example, companies such as JP Associates and Suzlon have huge FCCB commitments. These sections help you understand both the industry and the company’s position within.

Crunch the numbers

There’s no getting away from numbers - the next areas to look at are the all-important profit and loss account (P&L) and balance sheet. They provide data on sales, profits, debt, assets and so on. Where a company has subsidiaries and incorporates these accounts with itself, look to the consolidated financials to get the correct financial position.

If you just want to know what a company does and how much money it makes, stop here. But if you would like to dig deeper, financial information is at its most detailed in annual reports.

Note the notes

Items in the P&L and the balance sheet are broken up into smaller components in the schedules or notes to the account so that you can make more sense of the accounts — raw material is cost head, but what exactly are these materials? For instance, Emami spent Rs 415 crore on raw materials in 2011-12. But knowing what these are — namely, oils, herbs, packaging material and chemicals — will tell you prices of which commodities affect Emami’s costs the most.

Apart from explaining the P&L and balance sheet in finer detail, notes and schedules to accounts reveal more. Changes in accounting policies such as depreciation or foreign currency treatment feature here. The extent of disclosures in the notes is a measure of the company’s transparency. You can also skim the auditors’ report at the start of the financials section — missteps on the company’s part are qualified here. The rest of the annual report contains cash flow and fund flow statements, resolutions and why they were passed, management background and remuneration, , and so on.

(This article was published on September 1, 2012)
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