|
|
 |
|
|
|
|
Introduction
This guide will walk you through the basics of how to read an annual report. Knowing how to read the information provided in annual reports may help you become a more informed investor. Even if you have no prior experience in finance or accounting, understanding a few simple concepts and guidelines goes a long way.
This guide is available to help you in two ways. You can read the entire guide here, or read excerpts while exploring the site. Whenever you see an  icon in the “Page Tools” section of the left column, you can click it to link directly to the guide entry on that section. The guide also contains a glossary of common terms to which you can refer by clicking on the icon next to a glossary word as you explore the site.
Why Companies Publish Annual Reports
An annual report includes information about a company’s performance during the previous year, as well as management’s view of the company’s strategy for the future. It is one of the most important communications that publicly held corporations provide to the investing public.
Companies create and distribute their annual reports in order to:
| 1. |
Present an overview of the company, management’s discussion of the company’s recent performance and the company’s plans for the future.
|
| 2. |
Report the company’s financial performance for the most recently completed year and compare it with performance in prior years.
|
| 3. |
Fulfill part of their obligations for public financial reporting mandated by the Securities and Exchange Commission (SEC), the primary securities regulatory body of the United States government.
|
|
Why Investors & Analysts Read Annual Reports
Investors and investment analysts read annual reports in order to help determine whether a company might be an attractive investment. Annual reports can contain useful information regarding a company’s corporate mission, business model, quality of leadership, financial performance and strategic direction.
Nonetheless, an annual report is only one of many possible sources of information for making informed investment decisions. Investors and investment analysts should also consider information that puts the annual report within a larger context. Other sources include investment analyst reports, the Securities and Exchange Commission’s EDGAR database of company filings, company press releases, industry association reports, the business press and others.
Sections of an Annual Report
Letter to Stakeholders
Annual reports often begin with a letter from the Chief Executive Officer (CEO) and/or Chairman. GE’s letter is called the “Letter to Stakeholders.” This letter includes management’s assessment of the prior year, as well as a discussion of future plans. The letter typically highlights the CEO’s priorities for the coming year.
“Stakeholders” refers to all of the people with an interest in the success and activities of a firm (in this case, GE). This includes everyone from shareowners and employees to members of the communities in which GE maintains operations. The notion of stakeholders reflects the impact firms have beyond their shareowners.
 Letter to Stakeholders
Financial Highlights
Near the front, annual reports often include a visual representation of important financial performance information. This allows management to present commonly requested measures of company performance. GE highlights the steady increase in consolidated revenues, earnings per share and cumulative dividend growth compared to that of the S&P 500.
Financial Highlights
Management’s Discussion and Analysis
Management’s Discussion and Analysis (MD&A) provides an area for management to characterize the company’s performance through a series of discussion points, in this case:
- Operations
- Financial Resources and Liquidity
- Selected Financial Data
- Critical Accounting Changes
Management’s Discussion and Analysis
Management’s Discussion of Operations
Management’s Discussion of Operations includes management’s commentary on the company’s overall performance (Consolidated Operations), as well as a breakdown by operating units (Summary of Operating Segments).
GE presents the 2003 results of its businesses within 14 operating segments. Most of GE’s businesses, such as Power Systems and NBC, are segments by themselves. Management discusses each segment and its businesses separately, and also discusses international operations.
Management’s Discussion of Operations
Management’s Discussion of Financial Resources and Liquidity
This section describes the company’s position relative to its cash requirements for continuing operations and servicing debt. Liquidity refers to a company’s ownership of and access to the cash necessary to cover ongoing operations and other financial commitments, such as outstanding bills and interest payments to lenders.
Management’s Discussion of Financial Resources and Liquidity
Management’s Discussion of Selected Financial Data
This section, required by the SEC, shows financial data that may be useful in highlighting trends. Given this purpose, it shows five years of data rather than the two or three shown in the financial statements.
Management’s Discussion of Selected Financial Data
Management’s Discussion of Critical Accounting Estimates
Here companies highlight certain accounting policies and decisions that they consider crucial to understanding their financial statements because their application places the most significant demands on the companies' ability to judge the effect of inherently uncertain matters on their financial results.
Management’s Discussion of Critical Accounting Estimates
Financial Statements
Introduction to the Financial Statements
Financial statements are required by the SEC and present a detailed summary reflecting the company’s financial performance over the most recent years, with a particular focus on the most recent year.
Financial statements present a summary of the financial situation of a firm based on total sales and expenses (statement of earnings), assets, liabilities and shareowners’ equity (statement of financial position) and the flow of cash in and out of the company (statement of cash flows). These statements help analysts assess the financial health of a company.
Consolidated and Supplemental Information
Annual reports provide consolidated results, meaning that the financial results of all of the company’s business segments and subsidiaries have been added together into one summary report.
Companies supplement these consolidated statements with a variety of other information and detail. GE’s annual report, for example, offers investors a great deal of information regarding specific businesses within segments.
GE also presents information pertaining to its financial services businesses, referred to in its annual report as General Electric Capital Services (GECS), and its industrial manufacturing and product services businesses, referred to in the annual report as General Electric (GE). Don't be confused; GECS and GE are both part of the General Electric Company. GE organizes and presents information in this way to enable investors to make meaningful assessments of items such as leverage, asset turnover and cash flow that bear on industrial and financial services businesses in different ways.
Management’s Discussion of Operations addresses each operating segment separately in order to give investors greater visibility into the activities and performance of each segment.
Financial Statements
Statement of Earnings
Also known as the “income statement,” the statement of earnings shows the company’s revenues minus expenses, interest payments, and provision for taxes. In essence: revenues less expenses less interest and taxes = earnings. Net earnings (the “bottom line”) refers to earnings after income taxes have been subtracted.
The Per Share Amounts section presents GE’s net earnings divided by the number of shares outstanding. Finally, the “dividends declared per share” shows how much GE declared would be paid to investors for each share owned as of a given date. Because GE typically declares a dividend in December of a given year that is paid in January of the following year, the amount declared is not equal to the dividend paid in a given year.
Statement of Earnings
Statement of Changes in Shareowners’ Equity
This statement shows the changes during the year in shareowners’ interest in the company; for example, the increase in equity due to earnings and the decrease in equity due to dividend payments (which are distributions of equity to shareowners). Shareowners’ equity is calculated on the next statement, the Statement of Financial Position, by subtracting the company’s liabilities from its assets - the remainder is shareowners’ equity.
Shareowners’ equity does not reflect the market value of GE, which is expressed in the price of GE stock.
Statement of Changes in Shareowners’ Equity
Statement of Financial Position
Investors can think of this statement, also referred to as a balance sheet, as a snapshot of the company at a specific moment in time. In this case, GE’s statement shows the company’s financial position as of December 31, 2002, and 2001 for comparison.
The first section, “Assets,” lists all of the things owned by GE, starting at the top with highly liquid assets like “cash and equivalents,” moving down the list to less liquid, longer-term assets like “property, plant and equipment,” also known as fixed assets. A liquid asset is an asset that can be quickly converted into cash. As such, U.S. dollars, obviously, are the most liquid of assets in the U.S.
The second section, “Liabilities and Equity,” begins by listing all of the monies GE owes to others, or liabilities. This includes items like monies owed to companies that sell products and services to GE, also known as “accounts payable,” to liabilities like long-term debt owed over many years to noteholders.
The “Liabilities and Equity” section concludes with a listing of the components of shareowners’ equity, including shares issued and retained earnings. Equity is also referred to as net book value, since it represents assets less liabilities.
Statement of Financial Position
Statement of Cash Flows
The statement of cash flows shows how much money moved in and out of a company during a particular period or periods. It is literally an accounting of the “flow” of cash. Cash flow is of critical importance to every company. Firms require cash to pay operating expenses, repay loans and make investments—everything to provide goods and services to customers.
It is important to recognize that earnings and cash flows are not the same. Cash flows reflect the total amount of actual cash that has moved in and out of a company during a specific period, whereas earnings represent the difference between revenues and expenses. The difference between earnings and cash flows can be seen in the purchase of equipment. There is an immediate cash outflow, but the effect on earnings is recognized over future periods as a non-cash depreciation charge.
The structure of the statement distinguishes between three different sources and uses of cash flow:
1. Cash from Operating Activities represents cash flowing in and out as a result of GE’s regular operating activities, like the manufacturing and sales of products and services.
2. Cash Used for Investing Activities refers to cash flowing in and out of GE as a result of investments the company makes in things like new production equipment, real estate or new facilities. Another item of interest to investors is cash paid during the period for acquisitions, listed in GE’s statement as “Payments for principal businesses purchased.” This section can also include things like cash inflows to GE as a result of selling off property, equipment, facilities and similar assets.
3. Cash from (Used for) Financing Activities reports cash that the company raised from or used for financing activities such as borrowing money, issuing corporate bonds or paying dividends to shareowners. Paying dividends is an example of “(Cash Used for) Financing Activities.”
The line “Increase (Decrease) in Cash and Equivalents During Year” shows the total change in cash position as a result of cash flows during each of the years listed: 2003, 2002 and 2001.
Statement of Cash Flows
Notes to Consolidated Financial Statements
This section is exactly what the title suggests: notes describing, supporting and providing detail on specific line items in a company’s financial statements.
Notes to Consolidated Financial Statements
Independent Auditors’ Report
The Independent Auditors’ Report is a confirmation letter from an accredited third-party public accounting firm confirming that, based upon their assessment, the company’s consolidated financial statements in the annual report fairly present the company’s financial position and the results of its operations in conformity with accounting principles that are generally recognized in the U.S. Federal securities laws require publicly held companies to follow Generally Accepted Accounting Principles (GAAP). For more information on GAAP, see the Financial Accounting Standards Board’s Web site.
Independent Auditors’ Report
A Few Suggestions for Further Information
Financial Accounting Standards Board (FASB)
FASB is a private sector organization that establishes standards for accounting and financial reporting practices. Its Web site (www.fasb.org) provides detail on the role of FASB and the Generally Accepted Accounting Principles (GAAP) used by financial managers to prepare financial statements.
Securities and Exchange Commission
The SEC’s Web site (www.sec.gov) offers investors a source for understanding the requirements the SEC places on public companies, as well as its efforts to regulate and monitor securities-related activities. The SEC also maintains the EDGAR database of companies’ SEC filings.
|
|
|
