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A short guide to the financial statements for equity investors
Every company produces annual financial statements. For listed firms, these can be large and run to 100 pages or more. The question for investors is – which parts of this chunky document should they focus on? Here is a summary.
What you get
Although no two sets of annual accounts ever look quite the same, they can be broken down into three main sections;
Let’s take each in turn.
This first section contains a lot of different reports, most of which are mainly narrative and help to tell the story of how the firm has been performing. Inevitably, being written by management, these can be something of a sales pitch. Here is the list of contents for Tesco PLC.
If I had to pick just three areas that I would focus on as an investor they would be;
The financial review gives an overview of the firm’s performance and position. As such it is worth using in conjunction with the financial statements (see below). Next, I would take a look at principle risks and note any additions or omissions, in the light of what other similar firms are declaring. Finally, I would always skim the directors’ remuneration report and compare it to previous years. An obvious question is whether what the directors are being paid correlates with the performance of the business, in particular when it comes to the highest paid director.
There are three key ones and I cover the main headings and how to interpret them elsewhere.
Anyone wanting to find out more may like to head to killik.com/learn and click on the financial statements tab. Under that tab you will find videos on balance sheet basics, profit numbers and cash flow. Although these pages are buried half way though most sets of financial statements, they are vitally important.
The bad news here is that behind the financial statements can sit another 20-30 pages of notes. Choosing what to read is daunting. I would suggest as a minimum you look at these three;
Skim the accounting policies note for any inconsistencies or changes from last year. Then take a look at what I call the “hidden nasties” note and finally do some ratio analysis using the five-year summary. Again, more information about how can be found under the ratios tab within the Learn section of the website.
The good news
As you make your way through a set of financial statements, bear in mind that your effort should be rewarded because, as a source of information, they are better than most;
That said, they are not fool proof, as recent high-profile collapses such as Carillion, have demonstrated.
Whilst they are a very useful source of both written and numeric information about how a company has performed, the financial statements also require some judgement and interpretation. Look, in particular, for changes, hidden risks and inconsistencies. Good luck!
To find out about how Killik & Co’s equity research team analyses companies, please contact an Investment Manager.
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