The backbone of fundamental analysis - Annual Report

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Remember your school days? At the end of every academic year, you’d be handed a report card, right? If you’ll recall, this report card mainly had two sections. The first probably showed all the marks that you scored in your various subjects. The second perhaps included the teachers’ review and remarks about your general behaviour. In other words, it contained a quantitative and a qualitative assessment. 

Similarly, when you draw up a quantitative and a qualitative report of a company, you have an annual report. And as we discussed in module 2 of Smart Money, the annual report is prepared by the management of the company itself. It is generally very lengthy, and it gets into the details of the multiple facets of a company. 

For example, take a look at the annual report of Hindustan Unilever Limited, a manufacturer of fast moving consumer goods (FMCG), for the financial year 2019-2020. You can download a copy of the report from HUL’s own website and have it open while you’re reading through this lesson. 

Using that report as a reference, we’ll try to learn how to read an annual report now. 

Contents of an annual report of a company

As you know by now, the format of the annual report of a company is not set in stone. It varies from one company to the other. But while the order of contents may be different, the core subject matter of the report is usually the same across companies. Let’s take a look at the contents of the annual report of Hindustan Unilever, starting with the ‘overview’ section.  

Overview 

This section of the report gives investors a brief insight into the various aspects of the company. Here are some of the sub-categories that you’ll find under this section.  

1. About the company

Under this subsection, you can typically find a short history of the company along with the highlights of the year gone by. In the case of HUL, they’ve also talked about their brand and product lineup, their supply chain metrics, and other miscellaneous information.  

2. Chairman’s statement 

Addressed to the shareholders of the company, the chairman’s statement gives you information on the performance of the company in the past one year. In the annual report of HUL, the chairman of the company has comprehensively talked about the financial performance, the company’s achievements, and industry trends. 

3. Board of directors

This subsection basically introduces the board of directors of the company to the shareholders. It contains the names of the directors and their position within the company, along with their headshots.

4. Management committee 

The management committee is a group of high-level executives who are in charge of various activities within the company. This subsection consists of the names of the committee members and their position within the company, along with their headshots. 

5. The company’s performance

This subsection consists of highlights of the performance of the company in the past year. It includes both financial as well as non-financial performance metrics. In the case of HUL, the performance section features the following two sub-categories.  

  • Financial performance: The report shows highlights of the profit and loss statement, balance sheet, key financial ratios, and share price details.  

  • Unilever sustainable living plan: This section of the report deals exclusively with the company’s initiatives with respect to promotion of sustainability and reduction of environmental impact. 

6. Macroeconomic conditions and outlook

This section of the annual report of a company gives you an overview of the industry that the company operates in. It also contains information on key trends and economic conditions that affect the company and its stakeholders, and the actions taken by the company to mitigate the impact. In the case of HUL’s annual report, for instance, you’ll find this information in the section titled ‘Our fast-changing world.’ 

7. The company’s strategy

The company’s vision and mission statements make an appearance in this section. Also, both business and non-business strategies adopted by the company towards satisfying its vision and mission are outlined here.  

8. The company’s business model

A concise blueprint or an outline of the company’s business model is typically mentioned in this section. It essentially gives the investor an overall look at how the company operates and the flow of the process that it implements.   

Reports

This section of the annual report of a company consists of a consolidation of various other reports that delve into the performance, regulatory, and governance aspects. Reading through these details, you can gain a lot of non-financial information about the company. Here’s what you’ll find under this section.

Report of board of directors and management discussion and analysis 

The management discussion and analysis part of the annual report of a company is an important segment. Since we’ve already covered it in module 2 of Smart Money, we’ll move on to the board of directors’ report. 

The board of directors’ report goes into the details of the various financial highlights and achievements of the company in the past year. It also includes comprehensive information on each aspect that affects the company, and the actions initiated by the entity with respect to those aspects. 

Typically, you can find the board of directors’ report covering these areas.

  • Stakeholder engagement 

  • Risk management

  • Financial review, performance, and disclosures

  • Annual report on corporate social responsibility

  • Business responsibility report

  • Corporate governance report

  • Secretarial audit report

  • Economic value added  

  • Other important information on employee stock option plans, dividends, mergers and acquisitions, loans, corporate governance, and related party transactions, among others.   

Financial Statements

Up until this point, we’ve been looking only at the qualitative aspect of the annual report of a company. With the start of the ‘financial statements’ section, we’re officially moving on to the quantitative aspect. Here are some of the company financial statements that you’re likely to encounter in this section of the report. 

1. Standalone Financial Statements

These financial statements pertain to the main business entity, which in our case is Hindustan Unilever Limited. The following are the statements that are listed in detail under this section. You will learn more about how to read through and analyse these statements in the upcoming chapters. 

  • Independent auditors’ report

  • Balance sheet

  • Statement of profit and loss

  • Statement of changes in equity

  • Statement of cash flows

  • Notes

2. Consolidated Financial Statements

If a company has one or more subsidiaries, it generally prepares consolidated financial statements that include financial information of the main entity and its subsidiary/subsidiaries. This is prepared in addition to the standalone financial statements.  

  • Consolidated independent auditors’ report

  • Consolidated balance sheet

  • Consolidated statement of profit and loss

  • Consolidated statement of changes in equity

  • Consolidated statement of cash flows

  • Consolidated notes

  • Form AOC-1

Others

This section consists of miscellaneous information and generally includes the following. 

  • Awards and recognition 

  • Corporate information

Wrapping up

The company financial statements, which form a major part of the annual report, contain a lot of information that you’ll find to be useful in fundamental analysis. The financials include the profit and loss statement, the balance sheet, and even the cash flow statement. These are the reports that we’ll be getting into in the upcoming chapters. 

A quick recap

  • The annual report is prepared by the management of the company itself. It gets into the details of the multiple facets of a company. 
  • In the section about the company, you can typically find a short history of the company along with the highlights of the year gone by.
  • The chairman’s statement gives you information on the performance of the company in the past one year.
  • Then, there are sections with the details of the board of directors and the management committee.
  • Another section highlights the financial as well as non-financial performance metrics.
  • The annual report also gives you an overview of the industry that the company operates in, the company’s vision and mission statements, and an outline of the company’s business model.
  • In addition to this, there is a section with the report of the board of directors and a section on management discussion and analysis.
  • You can also find a company’s standalone financial statements and its consolidated financial statements in the annual report.
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