Skimming an annual report
An annual report often has three hundred pages, and only about ten of them really matter. If you know which ones, you need half an hour.
Learning objective: After this lesson you can go straight to the few sections of an annual report that really matter for an assessment.
Start at the back. The first pages are advertising with smiling people. What matters is in the management report, the notes and the auditor's audit opinion.
Four Sections Worth Reading
Four places are worth it. First, the risk report, where the company itself has to write down what can go wrong. Second, the cash flow statement, because it's harder to dress up than profit.
Maturities and Auditor's Opinion
Third, the part of the notes that says when which debts fall due. Fourth, the audit opinion. If there are qualifications there, or the auditor was changed at short notice, that's a clear warning sign.
Comparing With Last Year
A trick for comparison: put last year's report next to it and look for sentences that have changed. Companies rarely change their wording without a reason. If last year's risk report said one customer made up 15 percent of revenue and now it's 30 percent, you know more than after twenty glossy pages.
The management report contains the forecast and the risk report. Most revealing is what has changed since last year, in wording and in the order of the risks. These sections are usually just carried forward. Newly added risks, or ones suddenly rated as more likely, therefore tell you more than all the rest.
The Notes
The notes say how the company valued things and where it used discretion. If it changes its methods, it has to say so, and that deserves attention. There's particularly much leeway in three places: when revenue counts as booked, whether development costs go onto the balance sheet as assets, and whether the value of acquired companies still holds.
Key Audit Matters
For some years now, the auditor has had to list key audit matters in the audit opinion. There they write which areas stood out to them because of large leeway. That's a direct pointer to where an independent expert saw the greatest risk of misstatement. Private investors usually overlook this section.
Summary
- Risk report, cash flow statement, debt maturities, audit opinion.
- Compare the wording with last year's report.
- Key audit matters show where the auditor saw risks.
Did you get it?
Why does the cash flow statement say more than profit?
Because it offers less leeway for dressing things up than reported profit.
Where is there the most leeway in accounting?
In booking revenue, in capitalizing development costs and in whether the value of acquired companies still holds.
What are key audit matters?
Areas the auditor names because the biggest leeway and risks of error lay there.
Check your understanding
Your task
Open the annual report of a company that interests you and go straight to the four places: risk report, cash flow statement, debt maturities and the auditor's opinion. Write one sentence of notes per place, with the page number. Then put the previous year's report next to it and mark one sentence in the risk report that has changed.
Sources and further reading
- The international auditing standard ISA 701 has required auditors of listed companies since 2016 to disclose the key audit matters in the auditor's report. View source ↗
Related
- Reading a balance sheetStage 4
- The key financial ratiosStage 4
- What a company is worthStage 4
- Matching questions for this stageQuestions