Of all the statements that come tumbling out of American corporations - letters to shareholders, proxies, press releases - the best known is the annual report.
It is a company's yearly reckoning, its report card to the public. Increasingly, too, it has become for many firms a showcase for their products and philosphies. Often glossy and colorful, today's annual report mixes corporate promotion and hype with legally required disclosures. It is more than ever, a picture book for grown-ups.
But despite all that goes into them annual reports still frequently miss their mark.
"Annual reports have been described as documents that are set in large type, require a great deal of effort to produce and, when completed, are cast before multitudes" says a report by the American Institute of Certified Public Accountants (AICPA). "Somebody has observed that those same characteristics might also apply to night-time sky-writing."
Studies show that 40 percent of the people who should be reading annual reports toss them aside unread. This simply could reflect people's general aversion to columns of numbers. It also could be blamed on information overload. Or lack of understanding.
Aware they haven't been getting their annual report messages across to everyone they'd like to reach, many companies have been trying to design more entertaining and easier-to-read reports.
"Clearly, the move is to be more personalized about what their companies do to present material in a way that's faster to absorb," said Paul Wyeiskata, a New York Stock Exchange official. "The trend particularly is to use more graphics - bar charts, color maps, pictures."
Some companies, naturally have been more innovative than others. Brockway Glass includes a glossary of terms in its annual report. Wheelarator Frye, a recycling firm prepares a special report just for kids.
Where most people go wrong when trying to understand annual reports is in attempting to read them as they would a book or magazine. The reports aren't for reading. As the AICPA notes, they're for referencing.
Annual reports include information for all sorts of corporate constituents investors and customers, employes and suppliers, the curious, the critical and the enforcer. The trick is finding the statements that suit your interests.
The information in an annual report is scattered throughout in no required sequence. Most reports, however, adhere to a common general formal.
A report usually begins with a table of the company's financial highlights followed by a letter from the chief executive officer. The letter describes the previous year's highs, and it is supposed to mention the lows as well. The letter is most important, though, for what the chief says about the company's prospects.
Next come pictures and prose decribing the corporation's business or businesses, a useful outline of just what the company does for a living. If a company is engaged in a number of activities, this description can help separate a firm's few serious business from its hobbies.
Finally come the numbers that tell you essentially whether a firm is ahead of its creditors and how much.
A few companies don't even bother with prose and pictures. The annual reports of Texas Instruments and Wm. Wrigley Jr. Co. include only the figures. In contrast, Gulf & Western's 1978 annual report ran 66 pages and included snapshots of movie stars John Travolta, Warren Beatty and Chevy Chase all of whom made films last year for G&W's Paramount Pictures subsidiary. G&W was so proud of its annual report in fact that it paid $3.3 million to insert the report in one week's issue of Time magazine.
What goes into an annual report is largely up to the company. More than any other required corporate statement, the annual report is given considerable freedom of format.
It used to be that companies could publish any type of report they wanted - or none at all. That changed in 1899 with a rule set down by the New York Stock Exchange that each listed company must publish once a year "a properly detailed statement of its income and expenditures . . . and also a balance sheet, giving detailed and accurate statement of the condition of the company at the close of its last fiscal year."
Then in the mid-1950s, major corporations begin publishing slick, magazine style report. This disturbed the Securities and Exchange Commission which worried that the report were becoming more promotional than informational. Since 1974, the SEC has issued stream of rules mandating certain information in annual reports, including the [WORD ILLEGIBLE] of a company's product lines and a list of the quarterly prices of the firm's stock.
The core of an annual report is still the columns of numbers showing the win-loss record of the company's financial operations. The numbers are grouped in three sets:
Income statement. This shows the profit pictures for the year just ended and compares it to results for the year before. The key number here is "net earnings." But it can be misleading. The final earnings figure occasionally includes one-time gains or losses resulting perhaps from the sale of a subsidiary. Frequently, too, it includes gains or looses from foreign currency fluctuations. For these reasons, it is a good idea to look above net earnings at the figure called "income from operations."
Changes in financial position. This statement tells you what funds flowed into the firm to balance the funds shown flowing out. Note the number across from "working capital provided by continuing operations." The question to ask is, Did operations alone generate enough cash to meet payroll, buy raw materials and conduct other essential day-to-day operations of the company?
Balance sheet. Here you will find the value of the firm, its assets and liabilities, what it owns and what it owes. Look at how much cash the company has. Check the "accounts receivable" - that's how much the company's customers have bought on credit. Look, too, at what has happened to the firm's short-term and long-term debt accounts.
If you want to know why the numbers turned out as they did, read the section called "analysis of operations."
Also - and this is important - skim the foot-notes that come after the financial statements. Nobody except lawyers and accountants likes footnotes, but they do reveal information - such as whether the company is holding funds in reserve for all the lawsuits pending against it, or the kind of depreciation method it is using (the slower the depreciation method used, the greater the profits will appear).
You also should glance at the letter from the company's outside auditor, which is reprinted at the end of the annual report. If the auditors found anything suspicious, or disagreed with the company's own accounting, they will let you know about it.
Never satisfied with the pages of numbers already in an annual report, financial analysts love to look at ratios. They divide numbers from the income statement and balance sheet into each other to generate still more numbers.
Some of these ratios actually can be useful in reading between the lines of an annual report and determining just how well a company is performing. Few of the ratios are very meaningful by themselves. They should be judged against both an industry average and the corporation's history trend.
Among the more significant ratios are:
Debt divided by equity, which shows whether a company has been borrowing more from banks or from itself or shareholders to finance operations. (Equity is the value off a company's outstanding stock lus the accumulation of earnings, called "retained earnings," that have been reinvested in the company over the years.)
Current assets divided by current liabilities, which measures how solvent the company is. This answers the question. If all its short-term debts came due, could the company cover them with short-term assets?
Earnings per share, which is earnings divided by the number of shares outstanding plus a rather complicated accounting for what are called stock equivalents.
Return on equity, which is earnings divided by stockholders' equity and shows how well management is doing in making a return on what investors have in the company.
Just when you think understand the annual report of a corporation, you will open one for a nonprofit organization and become thoroughly confused again. There is a considerable difference between the two reflecting the different reasons for this being.
To start with, nonprofits don't think in terms of profits and losses. They think - and account - in terms of stewardship. That is their responsibility is to show that the funds entrust [WORDS ILLEGIBLE] have been used for the proper purposes.
The financial statements for nonprofit groups therefore are broken down into various funds. There are generally four - an unrestricted fund, a restricted one, a land and equipment fund, and an endowment fund. What went into and out of each fund is shown. So are tranfers between funds.
Malvera Moss a Price Waterhouse accountant in Washington and an expert on nonprofits, offered these tips for reading non-profit-group annual reports:
Look to see whether the charity really needs your donation. How much of the money taken in during the year was spent, for example? And even if all the money was spent, was there a pattern of surplusses in previous years?
How much money was spent on fund raising? Compare this figure to the amount of contributions raised. There is no rule of thumb for this ratio, but it shouldn't be more than a small fraction for old charities. New charities are likely to show a somewhat greater ratio.
Compare the amount of money spent on each specific program to the organization's total costs. Is it putting its money where itsays it is in its fund raising appeals?