Let us now look at how the annual report and
accounts is structured. The first major item is
the chairman’s statement. It shows the company
in the best light, so read between the lines.
At the end of the annual report is the auditor’s
report. It normally tells you that the accounts
are a true and fair representation of the company’s
financial state. If the auditor qualifies the
accounts, it is a warning sign, and you should
probably not invest in, or stay invested in, the
company.
Sandwiched between the chairman’s statement
and the auditor’s report are, among other
things, the three main financial statements: the
income statement (also known as profit & loss
account), the balance sheet and the cash flow
statement. Each statement shows the latest year’s
figures alongside the previous year’s for
comparison.
You should read the three statements in conjunction
with the notes to the accounts, which are like
the small print in a contract. If you do this,
you will get as full a picture as possible. Before
we take a more detailed look, note that from 1
January 2005, International Financial Reporting
Standards (IFRS) came into force for all listed
companies in the European Union and, in the next
few years, will be adopted in 90 countries.
At present, unlisted companies are allowed, if
they wish, to continue to use UK Generally Accepted
Accounting Principles (GAAP), but the trend is
in the direction of IFRS.
Under IFRS, company accounts disclose more and
tend to be longer. Any material error discovered
when converting from UK GAAP to IFRS must now
have been corrected. Let us look at each of the
main IFRS financial statements in turn.
Income statement
The income statement records the company’s
profits or losses, and how they were reached.
At the top is turnover (or revenue), which is
all of the ordin¬ary income received by the
company. Cost of sales, including production overheads,
depreciation and stock changes, is deducted from
turnover to show gross profit and, after some
other adjustments, operating profit. There is
a tax charge, including corporation tax and deferred
taxation, which typically amounts to less than
the pre-tax profit multiplied by the tax rate.
The statement looks something like this:
| Consolidated
income statement (IFRS style) |
£,000 |
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15 |
Turnover
Cost of sales
Gross profit
Administration costs
Distribution costs
Other operating income
Operating profit
Finance costs
Share of (loss)/profit from associate
Profit before tax
Taxation
Profit for the year
Attributable to:
Equity holders of the company
Minority interests |
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X |
Balance sheet
The balance sheet is another key financial statement
and it is best described as a snapshot of the
company’s position at a given time.
Anthony Bolton, fund manager at Fidelity Special
Situations, says that when he has lost a lot of
money on a stock, the underlying company has usually
had a weak balance sheet. “I now avoid such
stocks or take a smaller stake,” he says.
On the top half of the balance sheet are the company’s
assets, which are those items the company owns.
They are offset against the company’s liabilities,
which are what it owes. Total assets less total
liabilities equal the net assets of the company.
Current assets less current liabilities make net
current assets, which is the amount available
to pay bills within the year.
Issued share capital and reserves are the shareholders’
funds. These, to¬gether with any minority
interests, are equal to total capital employed.
The key rule of the balance sheet is that a company’s
total assets equal its total liabilities plus
its shareholders’ funds. In this way, the
balance sheet balances. It looks like this:
| Balance
sheet (IFRS style) |
£,000 |
|
ASSETS
Non-current
Assets
Property, plant and equipment
Intangible assets
Investments in associates
Available for sale financial assets
Derivative financial instruments
Total non-current assets
Current Assets
Inventory
Accounts receivable
Investments
Cash and cash equivalents
Total current assets
Total assets
Non-current
liabilities
Accounts receivable/payable in more
than one year
Provisions
Current liabilities
Accounts receivable/payable within one
year
Net current assets
Total assets less current liabilities
Net assets
Capital and
Reserves
Issued share capital
Share premium account
Revaluation reserve
Retained profit
Minority interests
Total equity
|
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
|
Cash flow statement
The cash flow statement shows movements in cash
and cash equivalents. It is often the part of
the accounts that investors and users find most
useful because it is not impacted by subjective
judgements or assumptions. All cash flows are
split between operating, investing and financing
items. Profits, as one punter has put it, are
a matter of opinion, but cash flows are unchangeable.
The statement starts with cash flow from operating
activities. The net figure will be preferably
about the same as, or, better still, higher than,
the operating profit on the profit & loss
account.
Next come investing cash flows, which include
those relating to the purchase or sale of long-term
assets, and movements in debt or equity in other
companies. Interest payments and receipts as well
as dividends appear in this section.
Finally we have the financing section, which shows
how the company obtains cash to finance its operations
and related payments. The cash flow statement
looks like this:
