Are your bored by the spate of voluminous books that flood your mail box every now and then? In most cases you spend part of your hard –earned resources to dispose them. Why do companies continue spending to print these reports every year or send CDs? Do investors need it and of what use are these reports? If annual reports are of any importance, how do investors make use of them? I will make attempt to answer some of these questions and also shows investors simple ways to make use of information in companies’ annual reports. I will focus on computing financial ratios with information in annual reports and how this could enhance your investment decision making.
An annual report is a statement prepared by companies (public or private) and distributed to employees, customers, shareholders, and the general community at the end of a company’s fiscal year. The contents of an annual report provide information about how well the business is doing financially, upcoming changes projected for the next year, and the management staff of the company. Concerned parties, such as shareholders, can use an annual report to make important decisions and decipher information which may not be apparent at first sight
At a minimum, an annual report must include a balance sheet, a report from an independent auditor, an income statement, and a general report on company operations. Most companies, however, use the document as a marketing tool as well, and take time to talk about the history of the industry the company is involved in along with emerging trends.
When it comes to investing, analyzing financial statement information is one of, if not the most important element in the fundamental analysis process. At the same time, the massive amount of numbers in a company’s annual report (financial statement) can be bewildering and intimidating to many investors. However, through financial ratio analysis, you will be able to work with these numbers in an organized fashion. A principal tool in financial analysis is the study of financial ratios which is computed from various items of the balance sheet and income statements of a business corporation.
Before investing in any company, investors are advised to be able to read a company’s financial statement so they can answer the following:
• Does the company have the money to meet its financial obligations?
• How much money have the shareholders invested in this company?
• How does the level of assets compare to the level of liabilities?
• What is the quality of the company’s assets – check for provisions for doubtful and bad debts?
Financial statements will tell you how good the company is at making money, what they own and owe, as well as how they are paying for their operation and future growth.
While a balance sheet gives a snapshot of a company’s financial position at a point in time -that is, the company’s assets, the liabilities and shareholder funds, the income statement gives the net earnings of the company during the stated time period. It shows the income, expenditure, tax, net profit, distributed profits and retained earnings of the company.
The cash flow statement on the other hand measures the liquidity of a company, by providing a better picture to investors on its ability to pay off its bills, creditors, and finance growth. In fact, a company can be profitable and yet run out of money.
Analyse the financial statement with ratios
Ratio analysis is the most widely used technique for interpreting and comparing financial statements. These ratios are particularly useful for the purpose of comparing the performance of a company from year to year and for comparing the performance of companies in similar industries. A large number of percentages and ratios have been developed for use in financial analysis. Some of those ratios have general application while others have more specialized use in specific circumstances.
To analyse the information within the balance sheet and profit and loss account, financial ratio analysis is used. The main types of ratios that use information from the financial statements are financial strength ratios, activity ratios and profitability ratios.
Financial strength ratios, such as the working capital and debt-to-equity ratios, provide information on how well the company can meet its obligations and how they are leveraged. This can give investors an idea of how financially stable the company is and how the company finances itself.
Activity ratios focus mainly on current accounts to show how well the company manages its operating cycle (which include receivables, inventory and payables). The main activity ratios are debtors’ turnover ratio and inventory turnover ratio. These ratios provide insight into the operational efficiency of the company.
Profitability ratios such as net profit margin, earnings per share, return on equity and return on assets provide information on a firm’s overall economic performance.
Below are some financial ratios definitions and formulas used in the annual report:
Net Working Capital = Current Assets - Current Liabilities Current Ratio = Current Assets/Current Liabilities Quick Ratio = (Cash + Marketable Securities + Receivables)/Current Liabilities
Accounts Receivable Turnover = Net Credit Sales/Average Accounts Receivable Inventory Turnover = Cost Of Goods Sold/Average Inventory Total Asset Turnover = Net Sales/Average Total Assets
Debt Ratio = Total Debt/Total Assets Debt/Equity Ratio = Total Liabilities/Stockholders' Equity Times Interest Earned = Earnings Before Interest & Taxes/Interest Expense
Gross Profit Margin = Gross Profit/Net Sales Profit Margin = Net Income/Net Sales Return On Total Assets = Net Income/Average Total Assets Return On Common Equity = Net Income/Common Equity
Earnings Per Share = (Net Income - Preferred Dividends)/Common Stock Outstanding Price/Earnings Ratio = Market Price Per Share/Earnings Per Share Book Value Per Share = (Stockholders' Equity - Preferred Stock)/Common Stock Outstanding Dividend Yield = Dividends Per Share/Market Price Per Share Dividend Payout = Dividends Per Share/Earnings Per Share
Financial analysis (though it requires a bit of number crunching) can be a productive starting point for assessing financial strengths and weaknesses, credit worthiness and other attributes of a firm based on past performance.
The essence of savvy investing is to research your investments carefully and make use of all the information available. The view of media houses may not always be right and research reports have been way off the mark a number of times. So engage a professional investment adviser to guide you in your investment decisions.