How to read annual reports

THIS GUIDE IS NEITHER AN OFFER TO SELL, NOR A SOLICITATION OF AN OFFER TO BUY, ANY SECURITIES OF INTERNATIONAL BUSINESS MACHINES CORPORATION OR ANY OTHER COMPANY.

An annual report is exactly what it sounds like - a formal report on a company's performance in the preceding year. A public company produces an annual report for its stockholders, the people and institutions who own the company.

Other interested parties, such as customers and potential investors, read this report, too. In fact, the Securities and Exchange Commission (SEC), a U.S. government agency, requires a public company to keep stockholders informed regularly on the state of its business.

An annual report is one of the most important documents a company produces and is often the first document someone consults when researching a company. It reports how the company did financially and often explains the scope of its business mission and management philosophy.

For these reasons (and because the SEC requires publication of much of the information in the annual report), companies take the development of an annual report seriously. They carefully consider its design and construction and even the paper to print it on. Today, many companies also produce Web and CD-ROM versions of their annual reports.

Guide to annual reports: Anatomy

Anatomy of an annual report

While most annual reports contain optional elements, all reports contain information the SEC requires.

Optional elements include:

Financial highlights

Letter to stockholders

Corporate message

Report of management

Board of directors and management

Stockholder information

SEC-required elements include:

Auditor's report

Management discussion

Financial statements and notes

Selected financial data

Optional elements

Financial highlights. Probably the most often-read section of any annual report, these highlights give a quick summary of a company's performance. The numbers appear in a short table, usually accompanied by supporting graphs.

Letter to stockholders. This letter may be from the chairperson of the board of directors, the chief executive officer, or both. It can provide an analysis and a play-by-play review of the year's events, including any problems, issues, and successes the company had. It usually reflects the business philosophy and management style of the company's executives, and often it lays out the company's direction for the next year.

Corporate message. Some analysts, business executives, and stockholders consider this message an advertisement for the company; others find it useful. However, it almost always reflects how a company sees itself, or how it would like others to see it. Here, the company can explain itself to stockholders, using photographs, illustrations, and text. This message may cover the company's lines of business, markets, mission, management philosophy, corporate culture, and strategic direction.

Report of management. This letter, usually from the board chairperson and the chief financial officer, takes responsibility for the validity of the financial information in the annual report, and states that the report complies with SEC and other legal requirements. The discussion attests to the presence of internal accounting control systems that cover effectiveness of operations, reliability of financial reporting, and compliance with federal laws.

Board of directors and management. This list gives the names and position titles of the company's board of directors and top management team. Sometimes companies include photographs.

Stockholder information. This information covers the basics, the company's corporate office headquarters, the exchanges on which the company trades its stock, the location and time of the next annual stockholder's meeting, and other general stockholder service information. Stockholder information is usually in the back of the annual report.

Mandatory elements

Auditors' report. This summary of the findings of an independent firm of certified public accountants shows whether the financial statements are complete, reasonable, and prepared consistent with generally accepted accounting principles (GAAP) at a set time.

Management discussion. This series of short, detailed reports discusses and analyzes the company's performance. It covers results of operations, and the adequacy of liquid and capital resources to fund operations.

Financial statements and notes. These statements provide the raw numbers for the company's financial performance and recent financial history. The SEC requires three statements - statement of earnings, statement of financial position, and statement of cash flows - all covered in this guide (the statement of stockholders' equity is not addressed here). These statements include a comprehensive set of related notes that provide explanations, additional detail, and supplementary financial information.

Selected financial data. This information summarizes a company's financial condition and performance over five years or longer. Data for making comparisons over time may include revenue (sales), gross profit, net earnings (net income), earnings per share, dividends per share, financial ratios such as return on equity, number of shares outstanding, and the market price per share.

Guide to annual reports: Other financial reporting

Other financial reporting

The financial statements and related notes in the annual report are primary sources of financial information available to investors, financial analysts, and the public.

Other primary financial information sources include SEC Form 10-K , which the SEC requires companies to submit yearly. This audited form contains more detailed information than the financial statements in the annual report. Companies also provide interim financial reports to stockholders and file an unaudited SEC Form 10-Q quarterly. These quarterly reports provide briefer, more aggregated data for the quarter and year to date.

Companies provide summary financial information throughout the annual report and through news conferences and press releases. To obtain more financial information on companies, visit resources. Here, you will find Internet links and print and other resources to help you extend your investment-related education.

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