October 5, 2016

Getting the Most Out of Annual Reports

By: Billy Nguyen

Are you a shareholder or investor in a company? If so, then pick up that annual report and begin looking for these key essential items!

Current and potential investors like to know where, and how their hard-earned money is being utilized by the companies they invest in.  Annual reports are required to be filed by companies each year to report their performance.

A current trend in annual reports, companies are using public communication to play an important role in how they communicate with their investors.  Companies are rapidly crossing into the digital age of creating their annual reports online, using video clips, infographics and even animation to attract and engage investors.

Whether online or on paper, some investors read annual reports but fail to read them effectively.  Annual reports should be approached with a sense of skepticism.  In other words, you should be reading between the lines to decipher the actual condition of the company.  Here are some key essential items to look for in a company’s annual report:

At first impression, lots of glossy color pages filled with photos or meaningless graphics used as space-filler is usually a red flag.  An annual report should not just be a marketing tool, but rather a true representation of how a company performed.  Instead of pictures, look for text, financial statements, and notes that give insight to what the company has been up to.

A good letter to shareholders should be candid and honest, and should provide an insight on the company’s future and its economic or competitive condition.  At the very least, management should provide an explanation of changes in sales and earnings from the prior year.

As you glance over the profit and loss financial data, it is important to look for these trends: sales, earnings, and dividends.  The questions that you should be asking:

  • Are these trends getting better or worse?
  • How does it compare to industry norms?

Ideally, you should be looking for a rise in sales and earnings, with earnings rising faster than sales as the firm leverages its infrastructure.

When jumping over to the balance sheet, think about the following key items: How is the balance sheet changing over time?  How do assets compare to debt or other liabilities? Check out the cash flow statement and see if the business has been a generator of cash or a user of cash.  What have they spent their cash on?

Afterwards, it’s time to determine if there are any hidden surprises that you might have missed.  The management discussion and analysis is the section to go to.  You should read the risk factors and the legal proceedings section.  This will allow you to determine if this industry is highly fragmented due to a rise in competitors or if they are experiencing a period of volatility in stock price.

Last but not least, you should be looking for that “unqualified opinion” on the audit report from a Certified Public Accounting firm.  An ‘unqualified opinion’ states that the financial statements were audited in accordance with standards of the Public Accounting Oversight Board and “present fairly, in all material respects”.

So there you have it!  Those are some key essential items that you should be looking for when reading an annual report.  By focusing on the most important aspects of the company, it avoids time wasted on companies that do not meet your standards for investment.  For help reading between the lines of your annual report, contact us or give us a call at 216.524.8900

Hobe & Lucas Certified Public Accountants, Inc. is a full-service accounting and business consulting firm dedicated to providing clients with exceptional value.

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