Demystifying the struggle of reading annual accounts
Whether you want to find out how the company you work for is faring or you are auditing another organisation for a potential merger or acquisition, efficiently breaking down the various facts and figures in an annual account or report can be the ideal way to paint a clear picture of a business. It can be key to finding out crucial information about the structure of a business as well as its financial health. But if you’re not an accountant or a financial analyst, understanding the information contained in a company’s annual report can pose a challenge.
The financial statement
While a company’s annual report as a whole offers a window into a business, it is the financial statement that provides the real tangible insight. It is in this section that you’ll find details of a company’s performance data covering the last financial year. As a general rule, this part will be divided into an income statement, balance sheet and cash flow statement.
The difference between an income statement and a balance sheet
The balance sheet of an annual report offers an in-depth picture of a company’s financial health on a specific date. Quite often a company will pick a date that follows their most lucrative time of year, i.e. when business is at its peak; in order to have the healthiest looking balance sheet. A balance sheet will detail the company’s assets and liabilities in relation to the net worth or owners’/ stakeholders’ equity. The total assets must be equal to the net worth plus total liabilities, hence why the two sides should balance out. Generally a balance sheet will also portray the current period as well as a previous period, allowing you to see any significant changes that have occurred.
Conversely, the income – or profit and loss – statement is more of a video than a snapshot, because it shows how a company performed between two periods. More specifically, it shows how much money the business has made or lost during that time – in other words, whether the company’s operations have resulted in a profit or loss.
What the cash flow statement can show you
The main objective of the cash flow statement is to show the reader the company’s cash movements during the given period. These are generally separated into functions, namely: operational, investment and financial.
“At least as important as a company’s profitability is its liquidity – whether or not it’s taking in enough money to meet its obligations. Companies, after all, go bankrupt because they cannot pay their bills, not because they are unprofitable. Now, that’s an obvious point. Even so, many investors routinely ignore it. How? By looking only at a firm’s income statement and not the cash flow statement.”
The importance of the footnotes
Another area that’s easily overlooked is the footnotes within the financial statement in a company’s annual account. These should always be read carefully as they often contain crucial information about the company’s structure and finances that has not been published anywhere else in the report. For instance, they could include details on a management restructure or a bad debt that was written off. Information such as this can provide a clearer insight into the workings of a company than other parts of an annual report, which are often understandably presented with a marketing gloss in order to paint the company in the best light.