The annual report is designed primarily to satisfy the needs of existing and possible future shareholders for information about a company.
To do this it should be understandable and comparable, reliable and relevant. Financial statements are provided to assist and support their decision-making and to form the basis of a statement of the directors’ stewardship of the funds shareholders have invested in the company.
Financial accounts are not only a historic review; they also aim to assist users to predict the timing, nature and risks of future cash flows.
The annual report is an important document, containing not only the statutory financial statements, tables, notes and management reports but also anything else that the company may wish to disclose.
It is the formal report by directors to their shareholders of their performance during the year and the financial position of the company at the financial year end. It also has an important public relations role.
A quoted company may have many thousands of shareholders, and even though only a few hundred are likely to turn up for the Annual General Meeting (AGM), where the accounts are formally presented, all will receive a copy of the annual report as will anyone interested in the company who has requested one.
Who uses the annual report?
Shareholders and their advisers:
Shareholders range from individuals owning a few shares to institutions owning a large number, and it is a mistake to assume the requirements of these two groups for information about a company are the
same.
Meeting the requirements of the financial advisers and security analysts in a single annual publication is probably even more difficult.
Shareholders own the company and use the annual report to discover how their investment has been managed by the directors during the previous year. Investments are normally made and retained for
future income or capital gain.
The annual report provides a basis for assessing past trends, but shareholders will be most concerned with the level of dividends and capital growth they are likely to see in the future.
In assessing this they will look at a range of the measuring sticks including dividend cover and rate of return and debt/equity ratios.
The people who advise shareholders, those who earn their living on the strength of their analyses and forecasts of company performance, will look at a wider range of measures and will focus closely on indicators of the potential risks of investing in the company.
Shareholders and power
The majority of shareholders in a typical quoted company may make up 60–70% of the total number of shareholders but own less than 10% of the total number of issued shares. The bulk of the shares – and therefore effective control of the company – is almost always in the hands of a group of institutional shareholders, usually a few hundred, including insurance companies, trust and pension funds, banks and other financial institutions. When a group of institutional shareholders get together
to tackle a company they wield formidable power that cannot be ignored by even the most autocratic directors. These are the shareholders that the directors listen to and try to satisfy. Because of this, and
because they are well informed and highly competent in financial analysis, they are generally in a better position to know what is going on than the small shareholders.
Lenders
Lenders – providers of long-term and short-term finance to a company – include not only banks, other institutions and individuals but also suppliers offering goods and services to it on credit terms. They have a strong incentive to assess its performance. They need to be confident that the company can meet the interest payments due on borrowed funds and that the loans they have advanced to the company will be repaid when due. They are therefore likely to focus on profit and cashflow generating capability, and measures of liquidity, solvency and gearing . In assessing this they – suppliers in particular – often rely on professional credit-rating agencies which will vet and monitor their customers.
Management
Like other interested groups, management is concerned mainly with the future performance and financial viability of the company rather than its past record. Management’s key roles are planning and decision-making. Budgets are prepared and actual performance is compared with these.
To run the company, its managers need timely and accurate information.
The annual report gives them no help here. However, managers can be expected to take a keen interest in it – especially if they are entitled to bonuses based on the revenue or profit for the year. Such bonus
arrangements open the door to a conflict of interest between the directors and shareholders, as the company’s accounting policies are set by the directors, who will not be disinterested in the size of the bonus they get.
To counter this potential conflict, changes in regulation and practice are gradually closing this particular gap between common sense and commercial practice.
Employees and unions
Employees and their advisers or representatives turn to the annual report to help them assess a company’s ability to continue to offer employment and the wages it can afford to pay.
Employees who do not immediately turn to the pages detailing what the directors have been paid usually show greatest interest in the particular part of the business – the division, factory, section or department – in which they work. Evidence suggests they have less direct interest in, or sympathy for, the company as a whole. Generally, employees are less able to read an annual report, which can create difficulties. Companies are therefore increasingly providing employees with a separate report or briefing that provides a clear summary of important matters.
Government and the taxman
Annual reports and the information filed with them may be used by the government for statistical analysis. Company and personal taxation are often based on the statement of accounting profit given in annual reports. However, in most countries a company’s tax liability is not fixed on the basis of the published annual report but on a separate set of accounts and calculations produced for tax purposes and agreed with the tax authority.
Other users
Customers of a company will use its annual report to look for reassurance that it will be in business long enough to fulfil its side of any contracts it has with them. This is particularly important in the cases of, say, a large construction project spanning several years, or the provision of a product or service where future continuity of delivery and quality is essential.
The failure of the supplier could have heavy cost implications for the customer.
