Annual Report Insiders Guide: What Are They Telling Me?
The Modern Annual Report to Shareholders does not look like a dreary financial report. Instead, it looks more like a glossy marketing brochure. In fact, annual reports do have a marketing purpose.
Yes, the mandatory financials, notes, and auditor’s opinion are all there. These are usually in black and white and small print. But these are sandwiched between many glossy pages with striking images, creative typography, colorful graphs, and artful prose from the Board, CEO and other officers.
For more in-depth coverage on reading and understanding annual reports, please see the article Annual Reports.
In response to the non-mandatory gloss, report readers naturally ask: “What are they trying to tell me?” Or, more to the point, “What are they trying to sell me?” And, “Do I buy it?”
Firstly: Understand the Annual Report Narrower Purpose
Annual Reports to shareholders exist because governments everywhere regulate the public trading of ownership shares. Most regulatory bodies have a declared mission similar to that of the US Securities and Exchange Commission (SEC), which is
“To protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”
In the regulatory context, therefore, the Annual Report’s reason for being is to enable investors to make informed decisions when (1) buying, holding, and selling stock shares, and (2) when electing directors.
Understanding these two points can rightfully be called Step 1 in learning how to read an annual report.
Secondly: Understand the Annual Report Broader Purpose
Readers know that the report authors—Board members and Corporate Officers—have a strong personal interest in helping investors make informed decisions and elect directors. To the authors, however, the Annual Report’s target audience extends well beyond the investment community. To the authors, the audience includes investors and also the company’s employees, customers, competitors, industry analysts, and even the general public.
Readers see instinctively that for all of these audiences, the broader purpose is to:
- Strengthen company branding
- Build confidence in the company’s future
- Show that management is firmly in control.
These points answer the question raised above: “What are they trying to sell me?”
After an especially difficult year, companies use Annual Report comments as a vehicle for rebuilding investor and public confidence in company management and in the company’s future. After a difficult year, the intended message is threefold. The purpose is to show the following:
- Leaders understand the reasons behind current problems.
- Leaders are acting to correct the problems.
- And, prospects for the future are good!
Seeing the nearly universal broader purpose might be called Step 2 in learning how to read an annual report.
Thirdly: Look For Answers to These 7 Questions
The reader must sort through marketing gloss, officer comments, Board and CEO letters, financial results, fine-print notes, and auditor’s opinion. So, what exactly should the reader look for in the Annual Report?
In reality, authors meet the report’s broader purposes via a short list of about 7 questions. Reports vary greatly in structure, length, and writing style, but if you know what to look for in advance, you should be able to see where the authors take on each of these questions.
- Firstly: Is the company operating profitably in its normal line of business?
- Secondly: Is the financial position strong?
- Thirdly: Are sales growing? And, are profits growing?
- Fourthly: How well is it competing? And, is it gaining market share?
- Fifthly: Is it earning good return on its asset base?
- Sixthly: Does the company have a good strategy for the future?
- Seventhly: Is it fixing known problems?
- Finally: Is it building value for owners (equity, dividends, and share price)?
Seeing that nearly all annual reports try to address these questions can be called Step 3 in learning how to read an annual report.
Annual Report: Where to Go From Here? Take Action!
Do you buy the report author’s message? For more on making that call and an overview of annual report structure and contents, please see the online article Annual Reports.
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