How to… Read an annual report

At
it’s most basic, a company’s annual report is a tool for an investor reviewing
their portfolio or sussing out their next stock purchase. But the ability to
interpret company results is another one of those must- have skills for HR
professionals wishing to leverage their position as key business partners.

In
the current economic climate, investors and analysts may be more concerned with
whether a company is holding its short-term value rather than how HR fits into
the business strategy. But company reports will be required to contain detailed
accounts of its human capital practices, and how they will add value for
investors. Annual reports also provide essential information on competitor
firms, such as directors’ compensation and work practices.

As
Brett Walsh, head of human capital at Deloitte & Touche, points out:
"Staff, branding and knowledge can be key contributors to market
valuation; so much so that company reports feature much more information than
just numbers.

"The
company report has become essential reading to understand its pivotal role in
supporting the firm, its leaders and its direction."

Where
do I start?

It
may look like a mass of confusing figures, but if you know what you are looking
at, an annual report can portray an accurate picture of the organisation’s
overall health.

Accept
that you are not going to master it in a few hours – some analysts and seasoned
investors devote days and even weeks to familiarise themselves with the wealth
of information in the reports.

You
will need to ignore the glossy photos and sophisticated graphics, and
familiarise yourself with the basic structure. Most conform to a set of
standard contents, including a brief overview of the firm and what it does, the
chairman’s statement, the chief executive’s review, the financial review
(including financial history over five or sometimes 10 years), the remuneration
report, the operations review, the auditor’s report, and a set of financial
statements. All are there for a reason, but some are more important than others.

The
language is likely to be upbeat, but be aware of phrases that indicate
potential problems, such as ‘except for’. Also look for honesty – are any
difficulties being frankly explained?

Do
I have to read them all?

Yes,
but not necessarily in the order they are presented, and analysts advise
starting from the back. It is the financial data in the latter part of the
report will reveal the most about a company.

Check
out the financial review – normally written by the firm’s chief financial
officer (CFO) – which charts its recent financial history, and provides an
analysis of the financial data in the report. It should also outline the
company’s future plans.

However,
the real meat of the report is found in the financial statements, where you can
see profit and loss statements and the balance sheets. This section may look
intimidating – it is full of accountancy-speak – but persevere, as it presents
a detailed picture of the company’s financial health.

The
footnotes attached to the statements are as important as the detail within
them. They are not always easy to decipher due to all the sector-jargon, but
they will disclose critical information such as whether a company’s profits are
from the disposal of assets, or income from core operations.

What
else can I glean?

Human
capital is famously considered as the only asset that doesn’t appear on the
balance sheet, but in future, you can expect to see far more data about a
company’s human assets – especially if HR plays its part in delivering
meaningful measurements.

In
the meantime, there’s bags of relevant information you can extract. It is a
great place to start if you wish to assess the quality of management, as you
can use the names as leads for further research. It will also show the make up
of the board – how long they have been with the firm, who has been brought in
and what impact any management change has had on share price.

Annual
report jargon-buster


Asset: Anything with commercial value, typically funds, plant and equipment securities


Balance sheet: A document that shows a company’s assets, liabilities and
shareholders’ equity


Cash-flow statement: Charts the money flowing in and out of a business and
covers the sale of goods and services (operations), capital raised (financing)
and future investment in the company


Debt-to-equity ratio: Any long-term liabilities divided by shareholders’ equity


Earnings per share (EPS): The allocation of a company’s profit to its
outstanding shares


Liability: Anything that can be deducted (typically loans or bills) from the
company’s assets


Market capitalisation: A company’s market value can be found by multiplying the
number of shares by its share price


Operating income: This is the pre-tax, pre-interest figure – calculated by
deducting operating expenses from gross profit.

Where
can I get more info?

Websites

www.companieshouse.gov.uk
This site allows you to search basic company information for free. Electronic
versions of reports and accounts can be downloaded

www.ft.com
The pink paper’s online site is a veritable storehouse of the latest business
news and market data.

Books

Understanding
UK Annual Reports and Accounts by John Laidler and Peter Donaghy, International
Thomson Business Press, £24.99, ISBN 186152109

If
you only do five things…

1
         Read your company’s annual report

2
         Make sure you read the notes

3          Go for lunch with the CFO (make sure
they pay)

4
         Join an investment club

5
         Bookmark www.ft.com

Expert’s
view: Brett Walsh on reading annual company reports

Brett
Walsh is head of UK human capital at professional service firm Deloitte &
Touche

Do
you think that HR professionals place enough importance on reading company
reports?

HR
professionals recognise that in today’s business environment their role is to
align HR activities to support the business goals and direction, however
challenging.

To
do this effectively, HR practitioners need to know what the leaders think and
the direction they are setting, and this is normally well documented in the
company report.

What
is your starting point when reading a report – do you find the section on
people strategy or check out the numbers?

I
tend to check out the numbers first – total revenue, the number of staff and
the disclosed employment expenses. Employment costs can represent a significant
proportion of total costs in many organisations – up to 70 per cent.

A
comparison with the previous year is also a good indicator of continuing
business performance and productivity improvement. Lots can also be learned
about the firm’s corporate values, which are typically key to its HR strategy.

What
mistakes should HR professionals avoid when reading an annual report?

The
disclosed employment costs exclude many direct and indirect costs, such as
training and software, and direct and indirect costs of HR in business units.
This fact may not be apparent to HR browsers unless the notes are read.

How
often do you read reports?

Whenever
I meet a new client I try to read their most recent accounts, although they can
be more than a year out of date. I also check if the HR director is on the
board. As HR becomes more strategic and less transactional, the trend will be
for HR directors to be on the board.

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