Reading a company's annual accounts can be a complex task – especially for nonprofessionals, but it is an important step in understanding the financial health of a business. So if you are the company boss and your accounts manager presents you with the annual accounts report for an overview, before submitting it to HMRC. What are you going to do? The following tips can help you navigate the information and make informed decisions about investing in a company.
1. Understand the Different Types of Annual Accounts: A company may have several different types of annual accounts, including a balance sheet, income statement, cash flow statement, and statement of changes in equity. Each of these documents provides important information about the company's financial performance and position.
2. Familiarize Yourself with Financial Terminology: To fully understand a company's annual accounts, you need to be familiar with financial terms and concepts. This includes understanding the difference between assets and liabilities, revenue and expenses, and cash flow and net income. Some of the popular terms used in annual accounts reports are:
An Asset: It is anything a company owns that has measurable value.
Liabilities: It refers to money that the company owes to debtors, such as B. staff costs owed, debt payments, rent and utilities, liabilities, and taxes.
Equity: It refers to the company's net assets. It is the amount of money that would be left if all assets were sold and all liabilities were paid. This money belongs to the shareholders, who can be private owners or public investors.
Revenue: The amount of money made by the company
Expenses: The amount of money spent by the company
Cost of Goods Sold (COGS): The cost of the components needed to produce what the company sells
EBITDA: Earnings before interest, taxes, depreciation, and amortization
Gross Profit: Total sales minus cost of goods sold
Operating Income: gross profit minus operating expenses
Income Before Tax: Operating profit minus non-operating expenses
Net Income: Profit before tax minus tax
Earnings Per Share (EPS): Divide net income by the total number of shares outstanding
Depreciation: The extent to which an asset (e.g. old equipment) loses value over time
3. Look For Trends Over Time: One of the most important things to look for when reading a company's annual accounts is trends over time. This includes comparing the company's financial performance in the current year to previous years, as well as looking for changes in revenue, expenses, and other key metrics.
4. Compare the Company to Its Peers: To get a more complete picture of a company's financial performance, you should also compare its annual accounts to those of its peers in the same industry. This can help you identify strengths and weaknesses and make more informed decisions about investing in the company.
5. Pay Attention to Footnotes: Many annual accounts include footnotes that provide additional information about the company's financial performance and position. Be sure to read these carefully and understand the information they provide.
6. Seek Out Independent Expert Analysis: You can also seek out independent analysis of a company's annual accounts, such as that provided by financial analysts or rating agencies. This can help you understand the company's financial performance and position in more detail and make more informed decisions about investing in the company.
How to Read the Individual Components of an Annual Accounts Report?
How to Read the Balance Sheet?
The balance sheet shows the "book value" of the company. You can see what resources are available to you and how they are funded at any time. Show your assets, liabilities, and equity (basically what you owe, what you own, and the amount invested by shareholders).
Financial statements also provide information that can be used to calculate returns and evaluate capital structure using the accounting equation: Assets = Liabilities + Equity.
A balance sheet by itself does not provide a picture of trends, so you must examine other financial statements, including the income statement and cash flow statement, to fully understand a company's financial condition.
How to Read an Income Statement?
An income statement, also known as a profit and loss account, summarizes the cumulative effect of transactions on income, profits, expenses, and losses over a period of time. Commonly shared as part of quarterly and annual reports, the document shows financial trends, business activities (revenues and expenses), and comparisons over a period of time.
How to Read Cash Flow Statements
The purpose of the cash flow statement is to provide a detailed picture of what happened to the company's cash during a specific period of time, called the accounting period. It shows the short-term and long-term performance of the organization based on the level of cash inflows and outflows.
The cash flow statement is divided into three sections: cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities. Ideally, cash from operating income should regularly exceed net income, as positive cash flow reflects a company's financial stability and ability to grow its business. However, positive cash flow does not necessarily mean that the company is profitable, so you also need to analyze the balance sheet and income statement.
How to Read the Annual Report?
An annual report is a bulletin that publicly traded companies are required to publish each year to shareholders detailing their operating and financial conditions.
Annual reports often include editorials and storytelling in the form of photos, charts, and letters from the CEO describing the company's activities, benchmarks, and results. They give investors, shareholders, and employees a better understanding of the company's mission and goals than individual financial statements.
Far from editing, the annual report summarizes the financial statements and includes the company's income statement, balance sheet, and cash flow statement. It also provides industry insights, management discussion, and analysis (MD&A), accounting principles, and additional investor information.
Conclusion
Overall, reading a company's annual accounts can be a complex task, but by understanding the different types of annual accounts, familiarizing yourself with financial terminology, looking for trends over time, comparing the company to its peers, paying attention to footnotes, and seeking out independent expert analysis, you can gain a better understanding of the company's financial performance and position and make more informed decisions about investing in the company.