What is an Annual Report?
KEY POINTS
An annual report is a key form of communication between a company and its shareholders, prospective shareholders, creditors, employees, market analysts, investment managers, regulatory bodies, and more
The executive team can highlight the company’s positive performance beyond what is disclosed in the audited financial statements
Non-financial topics may include governance, regulatory compliance, environmental impact, and workplace diversity
What is an Annual Report?
An annual report is so much more than just a set of financial statements that ticks the box on a list of regulatory reporting requirements.
It is a valuable communication tool that a company can utilize to connect with its board of directors, shareholders, employees, lenders, prospective investors, investment managers, market analysts and more.
It provides an opportunity for the company to go beyond its financial statements and highlight its many accomplishments and initiatives ranging from employee diversity to community and environmental impact.
In the U.S., public companies and registered mutual funds are required to produce annual reports with varied reporting deadlines.
Annual Report – Key Components
The reporting requirements related to annual reports will vary based upon the regulatory body governing the jurisdiction within which the company operates. An annual report will typically contain the following components,
Corporate Background
CEO Letter to Shareholders
Financial Highlights
Operational Highlights
Management Discussion & Analysis
Notes to the Financial Statements
The content related to such topics may be represented differently from one annual report to another. For example, a company may choose to have sections for lines of business, community impact, and human capital. Each section may contain disclosures referencing financial and operational issues pertinent to its respective topic.
Corporate Background
The disclosure of the members of the board of directors and executive team can provide insights into who is providing the strategic direction of the company. Individual biographies, if disclosed, provide professional and educational backgrounds on such individuals. There are many independent websites that users can access to gain additional information on a particular individual.
CEO Letter to Shareholders
The is an opportunity for the CEO to highlight the achievements of the past year while articulating their vision of the future.
The letter can range from a few paragraphs to several pages filled with narrative and supporting charts and pictures. It may reference financial performance, recent or pending mergers or acquisitions, divestitures, growth prospects, R&D projects, operational excellence, technological innovation, human resource initiatives, and more.
The annual report may also contain an additional letter from the board of directors, or a representative member thereof. Such may be brief, reiterate some of the CEO’s comments, and emphasize the board’s independence and ongoing involvement with management and any specific areas of the company with which the board may be directly involved.
Financial Highlights
This section may be less extensive than expected as much of the financial details are contained with the Management Discussion & Analysis and within Audited Financial Statements sections noted below.
The Financial Highlights section provides an opportunity to draw attention to very specific financial metrics pertinent to the company. It will typically include selected summaries of the income statement and balance sheet on a multi-year comparative basis. Such may include selected financial statement ratios that you can then compare to industry competitors to help assess the financial health of the company.
We invite you to read our related post How to Read and Interpret Financial Statements for an in-depth dive into the world of financial ratios.
The company may also include metrics related to the company’s stock performance and related shareholder rate of return over a multi-year period.
Highlights – Operational
The company can utilize this section to highlight a broad range of discretionary topics. It can often read as somewhat promotional while simultaneously providing valuable financial, regulatory, community and employee related information.
It may contain an overview of the industry, various lines of business, community impact, the products and services offered, major new contracts, geographical footprint, location of head office, number of locations, employee diversity and headcount, and more.
Management Discussion and Analysis (“MD&A”)
This section provides the opportunity for the executive team to present a more robust financial picture of the company’s performance. Such will contain qualitative and quantitative elements regarding the financial, operational, and regulatory aspects of the company. Such disclosures must meet regulatory disclosure requirements; therefore, the disclosures must be factual.
The MD&A can be lengthy and contain valuable information that is not contained in the audited financial statements. Users need to understand that the MD&A is not audited; therefore, an external auditor has not provided any assurance regarding the information disclosed. The MD&A represents the opinions of the executive team.
The executive team must strike a fine balance between providing investors, potential investors, and creditors with as much relevant information as possible without disclosing too much and providing competitors with an undue advantage.
The MD&A will often start with an executive summary followed by recent developments and financial highlights.
The financial highlights may provide substantially more detail than the audited financial statements. Such can include selected financial data, financial ratios, quarterly historical data, business segment operations, and more.
Additional disclosure may be provided related to governance, the board of directors and related committees, regulatory framework, and risk management.
Auditors’ Report
The auditors' report provides positive assurance in the form of an opinion that the financial statements are free from material error. The auditor utilizes the following methods during the audit:
Analytical
Inquiry
Internal controls
Confirmation
Review material contracts
Substantive testing
Physical verification
Fraud consideration
Audited Financial Statements
This section will include the balance sheet, statement of retained earnings, income statement, and statement of cash flows.
Balance Sheet
The balance sheet reports the assets owned, liabilities owed, and the equity of the entity at a specific date. The following equation is fundamental to understanding financial statements:
Assets = Liabilities + Shareholders’ Equity
Or,
Assets – Liabilities = Shareholders’ Equity
Statement of Retained Earnings
The statement of retained earnings shows the entity’s cumulative and current earnings.
Income Statement
The income statement shows the entity’s financial results for the period and consists of revenue and expense accounts.
Statement of Cash Flows
The statement of cash flows shows the entity’s cash flows during the period related to operating, investing, and financing activities.
Notes to the Financial Statements
The notes to the financial statements will disclose which accounting standard the financial statements have been prepared in accordance with (e.g., IFRS, GAAP) as well as the relevant accounting policies adhered to.
Do not gloss over the notes to the financial statements as they may contain material information that is critical to your decision-making process.
The notes may provide pertinent information pertaining, but not limited to; material assumptions made by management, stock option compensation, prior period adjustments, on-going or threatened legal action, subsequent events, and potential going concern issues.
Bottom Line
An annual report is one of the most important pieces of communication provided by a company to its shareholders, prospective shareholders, creditors, employees, market analysts, investment managers, and others.
The report is a regulatory requirement. It provides audited financial statements that have been opined upon by an independent auditor. It also contains an MD&A and other sections for the executive team to present a comprehensive quantitative and qualitative overview of the company’s performance.
We invite you to reference the following:
