The Hindu Business Line : Note the notes

Investors draw conclusions about a company’s performance from numbers as captured in its profit and loss account and balance sheet. But these numerical indicators don’t explain much about the source and the quality of earnings.

A detailed study of the notes to financial statements, allow you to go beyond the numbers to understand some of the assumptions and accounting policies that underlie them. For this purpose, we must refer to the notes to accounts, given as an appendix to the balance-sheet and profit and loss account.

Accounting treatment

Information contained in the notes clarifies the accounting treatment and explains the basis of valuation of the items in a financial statement. The Company’s Act mandates this additional disclosure. The extent of disclosure is a barometer of a company’s transparency.

Notes can be divided into three parts. The first part describes the basis of accounting and presentation. It briefs you on estimates used and where foreign exchange earnings are involved, the basis of conversion.

Some of the key points of information contained in the notes includes the position of cash and cash equivalents, collateral given to various lending institutions and investments in sister concerns.

The second part provides information on the assets and liabilities position. Here, related party transactions, that show a company’s dealings with group companies and associates, are a key source of information.

If a major portion of a company’s sales or purchases involve such entities, it may be a reflection on the core business.

Foreign exchange earnings and hedging transactions, which have been a key concern under volatile market conditions, are also clarified through the notes to accounts. The notes to accounts also provide important cues on the comparability of the profit or sales numbers from one period to another.

Mergers or acquisitions or divestitures of businesses can lead to sales or profits for one period becoming difficult to compare with another.

Decision-making tool

Maruti Suzuki, for the quarter ended March 31, 2008, changed its accounting policy on calculation of depreciation value of its assets. This had a sharp impact on the company’s profits. When the movement of domestic currency is volatile against others, the note on foreign currency transaction and hedging details becomes a must read.Other important aspects are contingencies, extraordinary items and events that occur subsequent to the balance-sheet date, which highlight the possible threats to the growth of the company.

For example, Suzlon Energy’s Rs 4693.6 crores of guarantees given in connection with acquisition of REpower find mention only in the notes.

Look for stability

The schedules to the financial statements give a break up of balance-sheet items such as inventories, property, plant and equipment, long-term debt, and stockholders’ equity.

These may be the key to making projections about a company’s future revenues and earnings. They also provide cues on how a company values its assets like stock, property and fixed assets.

The balance sheet numbers each line item to a schedule, which can be referred for further breakup.

So the next time you analyse a company, look beyond numbers. The financials are just one part of it. To get the bigger picture, note the notes!

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