Nine tips for reading Annual Reports from an Accountant. Annual reports often run into 100’s of pages. Here is what you need to know.
1. Read Back to Front.
Miss the glossy marketing pages and skip straight to the numbers. Before reading what the managers say about how well they have done, it is a good idea to have formed our own opinion.
2. Focus on Profit
There are so many ways profit is calculated the directors can be talking about a completely different number to the one considered most relevant.
Check the profit adjustment items under
Decide if they should be included.
3. Even Better Focus on Free Cashflow Over Profits
The best investors don’t spend huge amounts of time looking at a company’s profits. Instead, they spend a lot of time looking at its free cash flow in order to work out how good or bad a company’s shares might be as an investment
What is free cash flow? In layman’s terms it is the amount of cash that a company has leftover every year to pay its lenders and shareholders. It is essentially a company’s cash profits. Or essentially the cash which can be extracted from the company, whilst the company still maintaining its current growth.
A sign of a company with high-quality profits is that it turns a large proportion of its profits into free cash flow
4. Check the Segmental Report.
When a company is changing shape, using cash flow from one division with limited prospects to build up another which will diversify and grow its revenue. The Segmental report highlights this.
5. Check the Remuneration Report.
This is where executive pay is disclosed. Excessive pay counts against a company in my evaluations. It can mean the board is more interested in filling its own pockets than rewarding employees and shareholders fairly.
6. Don’t Overlook the Risk Section.
Companies do not like to talk about why they might lose money, which is what makes this section so compelling. Companies spell out the commercial challenges they face, and also present convincing arguments as to why they might overcome them.
7. How does it make money?
Read the business model section. A business model is how a company makes money. A strategy is how it plans to make more. To be credible, strategies must make sense, and they must be reflected in the results of the company.
8. Skip the Chairman Notes
Read the CFO notes. The chief financial officer will often repeat what the chief executive and chairman say but add more commentary on the numbers and how they were derived.
9. Check Accounting Treatments
Auditors very rarely qualify their opinion on the financial statements, but it can be useful to note which areas of accounting they focused their investigation on.
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