Question

As an investor, what would you look for in an annual report? Why are the notes to the financial statements so important?

Answer 1

An Annual Report of any company's is a comprehensive report on all the activities done by company throughout the preceding year. Shareholders,creditors,bankers and other interested parties use annual report to understand financial performance of the company.Investors will want to see in a company's financial statements before they will invest or loan to the business.

Annual report consist of following things which investors carefully go through..

1) Financial statement :

financial statements will reveal a company's Net Profit, Sales, Financial interest coverage ratio,etc. The Net profit is that a business has left over after paying all expenses.Any investors wants to see company profit,unsustainable profit are bad,tracking profitability is must before investing anything into business.As an investor analyses of Profit ,sales growth in upward movement gives green signal to invest in the business.

2)Cash Flow

In business,cash is like a blood to function whole operation of business.As an investor view of cash in the bank as a sign that company can deal with unexpected problems and capitalize on new opportunities.The amount of cash that's left after you meet your expenses each period, is a sign of sustainable operations. If company have cash balance,then investors won't have to worry that company could go under at any time.

3) Debt:

Debt scares investors for many reasons,

i) if in any case business goes on liquidate ,debt holders get their money back before equity holders have a chance to claim what's left.

ii) The Debt payment consume company's cash. High debt payments can hinder company's ability to meet payroll and other expenses during slow periods. They may also mean company have less cash available to handle a sudden surge in order or an emergency equipment replacement.

To measure short term or current liquidity of business there is quick asset ratio (current assets (excluding inventory) / current liabilities).A quick ratio of 1 indicates that company can exactly meet their obligation, and higher the quick ratio, more flexibility companies have.

4) Accounts Receivable Turnover:

Account receivable turnover indicates how long it takes company to collect money from customers, This tells investors two important things

i) Is Company willing to do what's necessary to make sure company get paid?Many new business owners feel bad asking for money and end up never getting paid. An investor looking for a return doesn't want to work with someone who isn't good at tracking down customer payments.

ii) Slow turnover combined with a large percentage of write- offs could indicate that many of company's customers don't have financially sound operations. This add risk to business model, and investors will want to see an increased return to compensate.

5) Director's report

In an annual report there is a section provides brief summary on Financials, explanation of the financial results, key developments in the company. Director report see whether management has achieved the set revenue target over the years, whether strategies adopted over the years were favorable for company and did management able to perform during roller coaster ride of an economy.

6) Information on shares of company:

This section provides information on historical performance of share price, share holding pattern of the company, pledging of shares by promoters during the year, split of shares, bonus shares distributed etc.

7) Auditors Report:

Auditor's comments on the financial matter of the company is must for any investors.Auditor's qualification on internal processes, information on change in accounting policy if any all are important to know as an investor.

NOTES IN FINANCIAL STATEMENT

In this section you will get information on accounting policy followed by a company, depreciation method, Forex losses/gains, segmental reporting, inventories, liabilities, leases etc.They are important in accounting because they provide additional information regarding methodology, valuation, time period and myriad other calculation nuances.Financial statements and reports provide a uniform framework for evaluating sales,net income,cash flow,assets,liabilities and stockholder equity. There are many different ways these accounts can be interpreted and valued based on both the business and industry. Notes provide an explanation for how the numbers in the financial statement, or report are calculated.

It will be helpful if investor read note to account section of last 3 to 5 years.This will help to get information on any change in accounting year or accounting policy which can inflate revenues or profit of the company, trend in segmental revenues/ profitability,contingent liabilities over the years, related party transactions etc.

As an investors reading an annual report is tedious exercise for the first time.However, its an suggestion to analyse at least 2 to 3 years past annual reports of a company to understand in and out about operations of the company, financials and management's stand in various economic trends.

Reading annual report is useful source to take a decision of buy,sell or hold of stocks with one's understanding