What Is Annual Report Of A Company?
An annual report of any company consist everything you need to know about it from statistics to future vision, however for beginners as well as experience investors reading and understanding these numbers does require some efforts and patience.
The annual report is published by the end of the Financial Year, and all the data made available in the annual report is dated to 31st March.
Likewise one can also see the quarterly and half yearly reports to gauge the overall performance during the current tenure.
Moreover, one cannot check every page of an annual reports as it contains many non useful details for you as an investors, therefore one should consider the main statements or financials numbers.
In order to know how to analyze Annual Report of a company you need to learn and understand three very important financials statements of any company present in its annual reports.
- Profit and Loss Statement also known as Income statement
- Balance Sheet Statement
- Cash Flow Statement
One not need to be from financial background or have done study of finance such as CA or MBA to understand this concept’s, having said that one do require a basic mathematics’ and a zeal to learn.
But at the first place why do we even need to know and understand how to analyze financial statements of a company or a stock? The simple answer is to avoid making bad decisions while you invest your hard earn money in them.
Financial statements tell us how much profit the company has been making over the years, whether that profit has been returned to investors in the form of dividends, what are the liabilities and whether the assets are sufficient to fulfill these liabilities of any company.
Before we proceed to learn about the basics of analyzing the financials statement, I would like to explicitly tell you that, if you do not have enough patience and eagerness do not waste time even reading this blog or any other better than this is to get an account with a stockbroker who gives you stock recommendation such as ICICIDirect Or 5Paisa.
Such stockbrokers have a research team who are better learned in doing fundamental and technical analysis for any company they recommend.
There is no guarantee whether it will perform according to the expectation and they might charge you a small fee for the service but this way you can focus more on your work, but if you are passionate enough do learn this skills of course you can do it.
So, if you are someone who want to do these analysis by yourself get ready to spent some time everyday reading and understanding the mechanics of what is known as fundamental analysis.
Just to clear few things and set the correct expectations even when you have learned to analyze any company financials statements it does not guarantee that the company will going to perform accordingly as there are many other risks involve when a business is run.
For example any company have 2 types of risks involved:
- Systematic Risk
- Non-Systematic Risk
A systematic risk is standard to all companies or stocks. Systematic Risk are commonly the macroeconomic risks & leave its impact in whole market. Reduction in GDP, Geo political risk, Higher Interest rate, Higher Inflation, Fiscal deficit, pandemic such as Covid etc.
Whereas non-systematic risk include events such as a strike, plunging revenues, Higher financing cost, Declining profit margins, a natural disaster such as a fire, or something as simple as Management misconduct or slumping sales.
Two common sources of unsystematic risk are business risk and financial risk. However non-systematic risk can be diversified, So instead of investing all your money in one company, you can choose to diversify and invest in 3-4 different companies (ideally from different sectors).
When you do so, unsystematic risk is drastically reduced. Now coming back to main topic let us go through step by step starting first with how to read an annual report of an company and what exactly it is.
How To Analyze Annual Report Of A Company?
Annual report of a company is just like a report card which contains all the financials numbers for that particular year in comparison to the last year highlighting company overall performance.
It is usually available on the company’s website (in the investor’s section) as a PDF document one can even get it from any exchange website such NSE or BSE or site such as tickertape or screeners.
For the sake of understanding and analyzing the annual report and financial statements I have taken an example of TATA Motors Limited, You can download Tata motors annual report for FY 2020 -21 from here.
As most of you be aware that Tata Motors Limited (TML) is a $44 billion organisation. It is a leading global automobile manufacturing company. Its diverse portfolio includes an extensive range of cars, sports utility vehicles, trucks, buses and defence vehicles.
Part of the USD 110 billion Tata group founded by Jamsetji Tata in 1868, Tata Motors is a subsidiary among many others.
Even Tata Motors Limited itself have many subsidiaries or part such as Jaguar Land Rover in the UK and Tata Daewoo in South Korea among many others.
When you read and understand the annual report there are two primary things to keep mind:
- Standalone financial statement or standalone numbers
- Consolidated financial statement or consolidated numbers
Standalone Financial statements represent the company’s standalone numbers/ financials and do not include its subsidiaries’ financials.
Whereas, the consolidated numbers include the companies (i.e. Standalone financials) and its subsidiaries financial statements.
One should prefer to look through the consolidated financial statements as it represent the company’s financial position better.
So in above case we will look Tata motors limited consolidated financials numbers which includes its subsidiaries as well instead of looking for just its standalone numbers.
Now coming back to annual report, it contains many section and sub section, keep in mind that no two annual reports are the same, they are all made to suit the company’s requirement keeping in perspective the industry they operate in.
However, some of the sections in the annual report are common across annual reports.
For example Tata Motors groups contains following important section in its annual report for FY 20-21:
- Company and Product Profile
- Chairman’s Message
- Key Performance Indicator
- Risk Management
- Board’s Report
- Managements Analysis
- Risk Factors
- Report on Corporate Governance
- Financial Statement (Standalone and Consolidated)
- Notice
Now out of above one of the most important are chairman’s message, performance indicator also known as financial ratios, risk factors and financials statements.
Mr. N Chandrasekaran is the Chairman and Non-executive Director of TML, Checkout the below snapshot taken from AR of TMG on what he has to say :
Although above is half part of the message you can read the complete message of the Chairman in its annual report. As you can see, he is telling you the about the challenges company has faced recently due to the pandemic and how they have still managed to run the business.
Not only that, TMG has also made improved in its EBIT (‘Earnings before Interest and Tax’) margins by 260bps to 6,471crore and Auto Free Cash Flows of 5,317crore despite its volumes declining by 10.3% to 902,648 units and revenues declining by 4% to 2,49,795crore.
From above message one can understand the efforts company have made in past and whether or not it has achieved its revenue targets.
Apart from that next in line is to look for key performance indicators, which tell us about the number of units sold in every segment, Revenue, EBITDA margin which is also one of the important financial ratio, Free cash flow, net debt etc.
Checkout the below snapshot taken from TMG annual report:
I am not going to discuss the financial ratios as of now, as it is a huge topic which can’t be discussed before one understand the financial statements.
Next is risk management section, where the companies generally talk about industry trends and what they expect for the year ahead.
This is an important section as we can understand what the company perceives as threats and opportunities in the industry.
One can read through this and compare it with its peers to understand if the company has an advantage over its peers or not.
For example, you can compare the commentaries based on risk and management from Maruti or Mahindra to see what they has to say.
Next in AR usually is the discussion on strategies and future roadmap to overcome any challenges and how they are going to do it.
The company will share each product line in case of a manufacturing company or will discuss different business segments, and how they have performed.
The annual report includes a series of other reports such as Human Resources report, R&D report, Technology report etc. Each of these reports is important in the context of the industry the company operates in.
For example, one can look human resources report to understand if the company has any labour issues.
If there are serious signs of labour issues, it could lead to the factory being shut down, which is not good for its shareholders.
Likewise, there is overall management analysis telling about the current industry and overall micro and macroeconomic trends making impact on company or entire industry.
Look at snapshot below telling about the overall economy trends:
Now, above all things are in an annual report can be understood easily just by reading and comparing it with peers. The core or crux lies in understanding the financial statements.
But even before you try to understand the financials statements such as P&L, Balance Sheet, Cash Flow you should be aware of few financials jargons.
Suppose you want to set up an auto manufacturing plant yourself however you do not have enough funds and need some money for the same. You have three options to raise funds:
- Take a loan at a fixed rate of interest from the bank or NBFC
- Take money from your friend and make him on board as an investor/shareholder of your company
- A mix of the above two options
Let’s say you chose the third option i.e. take some money on interest from bank and rest from your friend. Now suppose your total initial requirement is Rs.2,00,000 to setup the auto manufacturing plant.
You have decided to take a loan of Rs.100,000 from the bank and borrow the remaining Rs.100,000 from your friend. You decided to use the funds for the following purposes:
Rs 85,000 for machines
Rs 90,000 for building & other infrastructure and
Rs 25,000 for raw materials etc.
Before we move further I want you understand few important terms at this juncture:
What are Assets?
Here is the book definition which says, An asset is a resource with economic value that an individual, corporation, or country owns. In simple terms a useful or valuable thing.
You might have heard people saying ‘my friends are my assets’. But usually they do not know that assets are always equal to liability😂, how you will get to know later in the post.
Types of Assets, see the image below:
All the tools, machines, infrastructure, building and other things acquired by you for manufacturing are called assets. That is to say everything bought and owned by you using the money you raised, is classified as an asset.
Assets are created when funds are utilised to buy things that are going to help generate cash in the future. In above case, machines are acquired using the funds you raised and will help you generate cash in the future.
Assets further are classified into fixed, tangible & immovable assets and movable current assets. Plant and machinery will be classified as fixed, tangible and immovable assets because they are relatively immovable and have a very long life.
Whereas raw materials will be classified under movable current assets, as they have a very short life span and will be required to change at regular intervals.
What are liabilities?
In layman term, Liability means credit that’s it. Credit of an individual like loan, bills or a debt of an organization payable to banks or other lender. You can say it is a thing for which someone is responsible, especially an amount of money owed.
Types of liabilities check the image below:
As we know now that assets are brought by using funds, liabilities are the source of funds. As mentioned above, we have two sources of fund: banks and your friend. Hence the Total liability is Rs 2,00,000.
Liability, shows the company’s obligation, Any company takes up the obligation because it believes these obligations will provide economic value in the long run.
In laymen term Liability is nothing but the loan that the company has taken, and it is obligated to repay. Typical examples of obligation include short term borrowing, long term borrowing, payments due etc. Liabilities are of two types, namely current and non-current.
The most important thing to understand here is assets are always equal to liabilities.
The company’s total assets should be equal to the company’s total liabilities. Hence,
Assets = Liabilities
The equation above is also known as the balance sheet equation or the accounting equation. To be precise, above equation depicts the balance sheet’s key property, i.e. the balance sheet, should always be balanced.
In other words, the Assets of the company should be equal to the Liabilities of the company. This is because everything that a company owns (Assets) has to be purchased either from the owner’s capital or liabilities.
What is Equity?
In layman terms equity is nothing but ownership. There are various types of equities however in stock market world it is known as shares or stock. How much you own a equity in a particular stock refers to as equity holding.
In the accounting terminology or corporate world, equity (or more commonly, shareholders’ equity) means the amount of capital contributed by the owners.
In other words the difference between a company’s total assets and its total liabilities. If a person owns 1000 shares of total 100000 shares, then he owns 1% of the company.
Owners Capital is the difference between the Assets and Liabilities. It is also called the ‘Shareholders Equity’ or the ‘Net worth’. Representing this in the form of an equation :
Shareholders equity = Assets – Liabilities
The amount you borrowed from bank needs to be repaid over the next few years and will be classified as long term liability. Where as money you raised from your friend is not a loan but an investment in your company.
Thus it is classified as shareholder’s equity and your friend will be a shareholder of the company. Equity refers to the initial investment put in by different investors/shareholders.
In above case, it would be equal to Rs 100,000 investment put in by your friend.
A company can raise more funds through equity route by issuing new shares. In such a scenario equity will increase by a proportionate amount.
Leverage is the ratio of debt to debt plus equity (debt/(debt+equity).
In above case leverage is 50% (=100,000/200,000)
Hence your auto manufacturing firm is 50% leveraged. The debt/equity ratio of 1:1 or 50%:50% in this case, is also known as the capital structure of the firm. It tells us how much debt company has borrowed, compared to equity.
I hope you have got the basic idea behind assets, labilities and equity. Also keep in mind that Assets and Liabilities are part of balance sheet statement and not P&L.
The reason I told you before discussing the other financial statement is to make sure you have a basic understanding when you see the balance sheet on AR.
Now comes the most important of all the things i.e. the financial statements which is one of the most important aspects of an Annual Report.
As we have discussed at the top there are three financial statements that the company will present namely:
It is next to impossible to cover all of them under one post as they are huge topic hence I have made them available to read and understand in sections, you can click on above links in hierarchy for better understanding.
As a beginner in any field one should know that there is nothing called perfect start, one can do as much learning or practicing but at the end of the day what matters is involvement.
Learning about the finance and stock market requires indefinite time, hence start slow, steady step by step to reach the ultimate goal of financial freedom.
You can start trading or investing with as little as Rs.100, there is no compulsion. The amount of money or wealth you can create is unlimited, it up to you to decide when to start.
In the end remember this “Perfect is the enemy of good.” So keep learning.
So this was in brief I would say, How To Analyze Annual Report Of A Company In India.
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