Reading annual reports

It's annual-report time again! Although this time around, in deference to the environment, companies are forgoing glossy tomes in favour of soft copies of annual reports sent through email. A hard copy or soft, annual reports are usually a treasury of information. Here are pointers on how best to read them and what to look for.

Getting an understanding

Must-reads include the profit and loss statements and balance sheet. Apart from these, the Director's address gives an overview of your company's operational and segment-wise performance, key initiatives undertaken during the year, achievements and a financial snapshot. Annexures to these reports contain details on important items such as foreign currency convertible bonds (FCCBs) and their likely impact on total equity.

Move on to the management discussion and analysis (MDA) . It gives an industry overview, factors affecting prospects, impact of past and possible policy changes, potential threats and opportunities and finally, the company's own initiatives to exploit those opportunities or combat challenges. Often, plans for the coming year are outlined here. Also included could be production figures, manufacturing capacity utilisation, basic ratio analyses, risks and R&D efforts

Note the notes

You've now covered the main parts. But companies disclose so much more information either as part of the schedules and notes to accounts. Accounting policies refer to specific accounting principles followed by a company in the preparation of the financial statements and are disclosed as part of the ‘Notes to Accounts' in the annual report.

While accounting policies are generally consistent over a period of time, sometimes, it may require tweaking either due to regulatory changes or to aid better presentation of accounts. A simple example of this will be a case where the method of depreciation is altered from, say, straight-line to written down value. What holds relevance here is that it may have a one-time impact on the company's profits in the year of change. Because of this, the actual performance of the company may not be as good or bad as it may seem at first glance.

The ‘Notes to Accounts' could hold other bits of important information such as the calculation of the earnings per share after considering the potential dilution in equity base on conversion of FCCBs. Details on related party transactions, such as purchases and sales between holding and subsidiary companies, payment of salaries or perquisites to key managerial personnel and inter-corporate investments, loans and deposits, are also contained in the ‘Notes to Accounts'.

Other bits and pieces

Look at cash flow statements. Unlike the profit and loss account, which is based on the accrual method of accounting, this discloses the actual movement of cash. It is a useful tool to gauge a company's ability to effectively manage cash.

If, at the end of all this, you're still interested, go through the corporate governance reports to get to know the company's top management and the Board of Directors and their remuneration, and the shareholding patterns. If you have not kept a track of stock performance, the price trends too are displayed here.

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