I was inspired to write a blog about ARs having read a news story about Nokia’ latest fiscal report for 2014, which definitely suggests things are really looking up for the Finnish company.
The year over year change is about 9% from 3 476 million net sales in Q4 2013 to 3 802 million in Q4 2014.
This represents an even more impressive 14% quarter over quarter rise. Nokia seems to be getting on its feet again and predominantly thanks to Nokia Networks, which reals in more of the income with its operations stretching all around the world, but most notably in Europe and Asia-Pacific.
Operational profit increase is even more impressive with 28% overall growth from 2013 and an impressive 25% for Nokia networks in particular.
Bottom line, the Annual Report is a a corporate ‘work of art’ and isn't read like a normal book.
There’s no single author. No plot. No requirement to read cover to cover. No beginning, no end. Putting AR’s together year-to-year creates a ‘never ending story’ as the entity progresses along, merges, closes or is acquired.
The report and financials therein provide a snapshot at a given moment. By the time it’s posted, an annual report is more history than news.
Here are 5 Tips on how to read an annual report:-
1. Suggested Reading Order
Annual reports are not required to be written in any particular order.
The positioning of information is a great barometer of the past 12 months’ performance, Any annual report should have the onus of proving why performance was good.
A logical sequence for reading the various sections provided the beginnings of a framework for understanding, digesting and retaining the information as well as for performing comparative analysis.
This is especially helpful when an investor is considering investing in one of two or more companies in the same industry.
So the flipping back and forth from section to section will be worth the effort. Not all reports will have all the sections or the same type and level of information. A suggested reading order might be:-
1. CEO Message
2. Auditors’ Report
3. Management Discussion and Analysis
4. Multi-Year Summary of Selected Financial Data
5. Income Statement
6. Balance Sheet
7. Cash Flow Statement
8. Notes to Financial Statements
2. CEO’s Message
This section is the company’s best shot at providing good news about sales and profits.
Bad news, if stated openly and includes plausible explanations for turning things around, is acceptable.
Compare what the CEO delivered against what was promised during the previous year or two.
If the trend is consistently over-promising or under-performing, this is akin to an incumbent who promises to get things done during his/her next term.
3. Auditor’s Report
This is the endorsement of an accounting firm verifying that the financial statements were prepared according to pre-established rules.
The best report is a clean, unqualified opinion. If there are any qualifications or exceptions, the accounting firm either was not asked or is in no position to confirm certain financial facts by management or other accounts.
Be guided accordingly depending on the materiality of the information being referenced. Changing of accounting firms is usually a red-flag item. Accounting firms may be dismissed for reasons tied to performance or lack thereof.
More typically, they will not go along with certain management financial procedure or controls; and are replaced by a firm that will.
4. Management Discussion & Analysis
Similar, but with much more detail than the CEO’s Message, this section highlights various aspects of the company’s activities.
A typical report might include discussion and analysis on such topics as:-
• Change in accounting practises
• Acquisitions
• Market risks and competition
• Asset impairment • Business segment performance
This section also tends to be written in a more cautionary style than the CEO’s Message and should be read in conjunction with it.
5. Multi-Year Summary
This section’s greatest value is providing a quick opportunity to review financial trends.
Besides providing a quick overview of the current year’s financial performance, this section typically provides five years of comparable data for:-
• Sales The trend should be going upwards!
• Income from Continuing Operations The trend should be compared with the trend for net income. The difference between them might include gain or loss on sale of assets and other non-recurring items.
• Income per Share from Continuing Operations
This trend should approximate the income from Continuing Operations Trend. If the growth is faster, it could be the result of the company’s share buyback – usually a good thing. If the trend if slower, it may result from the company’s issuance of additional shares – not a good thing because the value of each share in the company is diluted.
• Long term debt
Debt is fine if it is growing proportionately with the sales and income growth trends. If it is growing at a faster rate, that’s not generally a good sign as the company may become overly leveraged.
• Ratios
Return on assets, return on equity and working capital is likely to be found in this section. Checking a company’s financial trends over several years provides a meaningful picture of where the company has been. It also puts into some perspective the CEO’s Message and Management’s Discussion and comments as to the future direction of the company.
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