How to read an Annual Report

How to read an Annual Report

If you had read my last blog post about getting started with Fundamental Analysis, you might know that the fundamental analysis of a company is very essential to find good businesses and the annual report of a company is one of the most important documents through which you will understand the business better.

So what is an annual report? 

It is a report published by a company yearly (by the end of the financial year) and all the information made available in the report is dated to 31st March. The report is available on the company's website (in the investor's section) as a PDF document and one can also contact the company to get a hard copy of the report.

Since the annual report is published by the company itself, so everything disclosed in the annual report is official and assumed to be true. If any information present in the report is false then it can be held against the company. To give you a belief, the annual report contains the auditor's certificate so, it tells you it's 100% valid and true.

An annual report usually contains more than 300 pages and lots of data are present and it is inefficient to read it all. But one must be very careful while going through the report because there are very tiny lines between the facts present by the company and the market content that the company wants you to read. 

So, what are the section that one must specifically read in an annual report to know the company and business well? Let's now look at the annual report of Maruti Suzuki and see how one should read it (https://www.marutisuzuki.com/corporate/investors/company-reports).

As we go through the report, we come across many sections, but the most important ones are:

• Performance Highlight or the Financial highlights
• Management Statement (message from the chairman)
• Management discussion.
• The financial statements.
• Notes.

So, let's start with the first section the financial highlights, here it gives an all-round view of the financials of the company in a year on year basis. These details are basically an extract from the company's financial statement. Do go through this section to get an overall idea on the company's performance, but do calculate these figures on your own from the financial statement to get better clarity on the company.

The next two sections i.e. The management statement and the management discussion are important because they give a sense of what the management of the company has to say about their business. 

In the management statement, the investors get a brief overview of how the top management person is thinking about the business. Here basically look how realistic is the management i.e. if the goal and other things they speak are really approachable also see if the management is transparent or not i.e see if they discuss details on the things that went right and what went wrong for the business.

Message from the chairman

New in the management discussion they discuss the overall economic activity of the country if the company has high exposure to export they even talk about the global economy and business sentiment. Also, here the company talks about the trends in the industry and what they expect for the coming years. This is one of the most important sections because here they discuss the threats and opportunities in the industry.

Also, the annual reports contain a series of other sections such as - Human Resource, R&D, etc. Each of these is important to the context of their respective industries. For example, while we are reading an annual report of the manufacturing industry then must have a look at the human resource section and see if there is a labour issue. If there are any labour issues then it could lead to the shut down of the factory and it is not good for the company and its shareholders.

The most important section of an annual report that every shareholder must-read is the financial statements. There are three financial statements that the company will be presenting are:

1. The profit and loss statement.
2. The balance sheet.
3. The cash flow statement.

The financial statement comes in two forms.

• Standalone financial statement.
• Consolidated financial statement.

Now, let us take an example to understand the difference between a standalone and consolidated financial statement.

Take Maruti Suzuki, about 56.28% of shares are held by Suzuki Motor Corporation of Japan. Hence, Suzuki Motor Corporation is the Holding Company or the promoter of Maruti Suzuki. However, Maruti Suzuki itself holds 100% share of True Value Solutions LTD, Maruti Insurance Business Agency Ltd, Maruti Insurance Agency Logistics Ltd, so they are the subsidiaries of Maruti Suzuki.

Now, assume that for the financial year 2019 Maruti Suzuki makes a loss of about ₹500 Crs. But its 100% subsidiary company True Value Solutions LTD. Make a profit of about ₹200 Crs. So what would be the overall profitability of Maruti Suzuki?

Well, it's very simple Maruti Suzuki on its own have made a loss of ₹500 Crs., but its subsidiary made a profit of  ₹200 Crs. So overall P&L is (- ₹500) + ₹200 = (- ₹300). Thanks to its subsidiary the overall loss decreased. 

So, now if you look at its consolidated Financial statement, you will find that the company had made a loss of ₹300 Crs. But if you look at its standalone financial statement you will find the company had made a loss of ₹500 Crs. 

Hence, a standalone financial statement represents financials of the company itself and not any of its subsidiaries whereas a consolidated financial statement consists financials from both the standalone and its subsidiaries.

Schedules of the financial statements.

When the company makes its financial statements, they report the full statement in the beginning and then only they give a detailed explanation of the same.

Here is a snapshot of Maruti Suzuki's financial statement (balance sheet):

Balance sheet

So, if you look at the balance sheet of Maruti Suzuki, you will notice that each particular in the financial statement is referred to as the line item. Here the first line item is Property, plant and equipment (under Assets). Now if you notice, there is a note number associated with the Property, plant and equipment. This is called the "Schedules" related to the financial statements. Looking further you will see that the Property, plant and equipment stand at ₹149,567 million. So, as an investor, you would be interested to know how Maruti Suzuki has arrived at ₹149,567 million and where does it hold its assets. To know you have a look into the associated schedule (Note 4). 

Here is a snapshot of the same:

Note

Also, remember that no two financial reports are the same, they all are made to suit the companies business and the sector in the sector in which they are working. However, most of the above sections discussed above are common across all annual reports.

~By Suddha.