Reading Annual Reports

11/7/2019 How to Efficiently Read an Annual Report
CORPORATE FINANCE & ACCOUNTING FINANCIAL ANALYSIS
How to Efficiently Read an Annual Report
BY SHAM GAD | Updated Apr 22, 2019
A company's annual report is the single most important way for potential investors to understand
the financial state of a company. A company annual report is also a marketing tool designed to
attract investors, and a company will attempt to present themselves in the best light possible
without violating any Securities and Exchange Commission (SEC) regulations. Unfortunately, while
many investors read annual reports, they fail to read them effectively. In other words, while annual
reports do not deceive or reflect false information about the business, investors should always
read them with a sense of skepticism. Learn how to read between the lines and decipher the actual
condition of the company.
Annual Report Versus 10-K Filing

Typically, a company will file both an annual report and 10-K report to the SEC. An annual report is
the shorter version that often comes with illustrations, glossy pages, a letter from the Chairman or
CEO, and an overview of the financials. The 10-K is a longer, more thorough black and white
document that a company is required to submit to the SEC.
https://www.investopedia.com/articles/basics/10/efficiently-read-annual-report.asp 1/6
Companies may merge the annual report and 10-K into one document with the annual report at
the beginning to provide an overview of the year's results. Sometimes, a business will file the 10-K
as its annual report since that document is mandatory for every public company.
If a company does file both reports, the annual report should be examined before the 10-K filing.
How To Efficiently Read An Annual Report
The Components of an Annual Filing

Investors always read the 10-K filing if you are interested in investing in a public company. The
report begins with a detailed description of the business, followed by risk factors, a summary of
any legal issues and, finally, the numbers and financial notes.
Often, the most essential components of the annual 10-K filing include:
Item 1: Business (a description of the company's operation)

Item 1A: Risk Factors
Item 3: Legal Proceedings
Item 6: Selected Financial Data
Item 7: Management's Discussion and Analysis of the Financial Condition
Where to Start
There is an efficient way to tackle annual 10-K reports. Read Item 1 first, which is the business
description. Item 1 explains what the company does, who its customers are, and the primary
industry in which it operates.
Next, Items 6 and 7 explain the financial data. A potential investor should assess how the company
has performed over a period. Also, the financial statements should indicate whether the balance
sheet has become stronger or weaker over time.
The cash flow statement should show whether the business has been a generator of cash or a user
of cash. It is possible for firms to report net income while, at the same time, having negative cash
flow. Compare the income statement with the cash flow statement for any red flags. For example,
steady cash flows are indicative of a healthy and thriving company, whereas large fluctuations in
cash flows could signal that a company is experiencing trouble. Large amounts of cash on hand
could indicate that more accounts are being settled than work received.
Look for Unusual Risk Factors

Potential investors should also consider any risk factors associated with the company. One risk
factor is legal proceedings that the company might be facing. Litigation activities should be
disclosed in the company information in a section called Legal Proceedings. The United States has
regulations that require companies to report any litigation, especially if it affects income.
Risk factors are filing to the SEC, and the company reports might include statements such as, and
"our industry is highly fragmented with many competitors" or "our stock price may experience
periods of volatility." While these are important risks to consider, they are common and should not
significantly reduce the desirability of the business. Unusual risk factors that require greater
attention are, for example, if the company generates a substantial portion of its revenue from just
one or two customers.
In addition, the Legal Proceedings section will reveal any significant lawsuits affecting the
company. While legal issues should be assessed, they may not be as severe as they seem. For a
billion-dollar company, a pending lawsuit for damages of $10 million is often an unavoidable part
of doing business.
For example, Pfizer, one of the largest drug companies in the world, may have pending patent
lawsuits and drug liability claims that may exceed hundreds of millions of dollars. But that's par for
the course for any major pharmaceutical company and a drop in the bucket for Pfizer, which had
over $19 billion in cash and short-term investments on the balance sheet at the end of December
2018
Focus on What You Know

There are different ways of interpreting financial information. Read the annual report in a way that
works for you, but learn to concentrate on the most important aspects of a company's 10-K filing.
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Related Terms
What You Should Know About 10-Ks
A 10-K is a comprehensive report filed annually by a publicly traded company about its financial
performance and is required by the U.S. Securities and Exchange Commission (SEC). more
What Is SEC Form 10-Q?

Learn about SEC form 10-Q, a comprehensive report of a company's performance submitted quarterly by all
public companies to the SEC. more
Why You Should Read a 10-K's Management Discussion and Analysis

(MD&A)
MD&A is a section of a company's annual report in which management discusses numerous aspects of the
company, both past and present. more
SEC Form N-CSR

SEC Form N-CSR is a form that a registered management investment company completes and files with the
Securities and Exchange Commission (SEC), following the transmission of annual and semiannual reports to
stockholders. more
SEC Form 6-K

The SEC Form 6-K is a form that foreign private issuers of securities are required to submit, pursuant to rules
in the Securities Exchange Act of 1934. more
Adequate Disclosure
Adequate disclosure is an accounting concept confirming that all essential information is included in
financial statements. more
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11/7/2019 How to Efficiently Read an Annual Report

CORPORATE FINANCE & ACCOUNTING FINANCIAL ANALYSIS

How to Efficiently Read an Annual Report

BY SHAM GAD | Updated Apr 22, 2019

Annual Report Versus 10-K Filing

How To Efficiently Read An Annual Report

The Components of an Annual Filing

Item 1: Business (a description of the company's operation)

Look for Unusual Risk Factors

Focus on What You Know

SEC & REGULATORY BODIES

What Is SEC Form 10-Q?

Why You Should Read a 10-K's Management Discussion and Analysis

SEC Form N-CSR

SEC Form 6-K

Terms of Use Contact Us News

Investopedia is part of the Dotdash publishing family.

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