An annual report is long because it is a legal document, not because all of it is written for you. On a first pass, most of it can wait.
In short
- Start near the back. The front is written to impress; the statements are written to comply.
- Five numbers, read across three years, tell you most of what you need.
- Cash from operations is harder to flatter than profit.
- The notes are dry and they are where anything awkward is disclosed.
Start at the back
The opening pages are marketing. Photographs, a letter from the chairman, selected figures chosen because they look good. None of it is dishonest and none of it is neutral.
The financial statements toward the back are prepared to an accounting standard and audited. Start there and read forward only when a number raises a question.
Five numbers
Revenue
What the company sold. The question is not whether it is large but whether it grew, and whether growth is speeding up or slowing down.
Profit
What survived after costs. Compare its direction to revenue. Revenue rising while profit falls means costs are growing faster than sales, which is a story worth understanding.
Cash from operations
The most useful number in the document and the least discussed. Profit involves judgement about when to recognise revenue and how to spread costs. Cash is harder to flatter. A company reporting healthy profits with weak operating cash deserves a closer look.
Total debt
What is owed, and what it costs to service. Debt is not automatically bad, but debt that consumes a large share of operating profit leaves nothing for anyone else, including you.
Shares outstanding
How many slices the company is divided into. If this rises year after year, the same business is being split further and your slice shrinks. This is easy to miss because it never appears in a headline.
One year is a photograph. Three years is a direction.
Read the notes
The notes to the accounts explain what the headline figures actually contain. They are where you find related party transactions, contingent liabilities, changes in accounting policy, and the auditor’s qualifications.
A change in how something is measured, disclosed in a note, can move a headline number more than anything the business did that year.
Questions worth answering before you buy
- Can I explain how this company makes money in two sentences?
- Is revenue growing, and is profit keeping pace?
- Does operating cash support the reported profit?
- Could it survive a bad year without raising money?
- Is my slice of it shrinking as new shares are issued?
If a company pays a dividend, the report is also where you check whether profits actually cover it. That connects directly to what a high yield is telling you.