Annual reports are formal financial statements that are published yearly and sent to company stockholders and various other interested parties. The reports assess the year's operations and discuss the companies' view of the upcoming year and the companies' place and prospects in their industries. Both for-profit and not-for-profit organizations produce annual reports.
Annual reports have been a Securities and Exchange Commission (SEC) requirement for businesses owned by the public since 1934. Companies meet this requirement in many ways. At its most basic, an annual report includes:
- General description of the industry or industries in which the company is involved.
- Audited statements of income, financial position, and cash flow and notes to the statements providing details for various line items.
- A management's discussion and analysis (MD&A) of the business's financial condition and the results that the company has posted over the previous two years.
- A brief description of the company's business in the most recent year.
- Information related to the company's various business segments.
- Listing of the company's directors and executive officers, as well as their principal occupations, and, if a director, the principal business of the company that employs him or her.
- Market price of the company's stock and dividends paid.
Some companies provide only this minimum amount of information. Annual reports of this type usually are only a few pages in length and produced in an inexpensive fashion. The final product often closely resembles a photocopied document. For these companies, the primary purpose of an annual report is simply to meet legal requirements.
Annual Report As Marketing Tool
Many other companies, however, view their annual report as a potentially effective marketing tool to disseminate their perspective on company fortunes. With this in mind, many medium-sized and large companies devote large sums of money to making their annual reports as attractive and informative as possible. In such instances the annual report becomes a forum through which a company can relate, influence, preach, opine, and discuss any number of issues and topics.
An opening "Letter to Shareholders" often sets the tone of annual reports prepared for publicly held companies. The contents of such letters typically focus on topics such as the past year's results, strategies, market conditions, significant business events, new management and directors, and company initiatives. The chairman of the board of directors, the chief executive officer, the president, the chief operating officer or a combination of these four usually sign the letter on behalf of company management. Some of these letters may run a dozen or more pages and include photographs of the CEO in different poses (some even expound on topics that, while perhaps of only tangential interest to stockholders and other readers, are of importance to the CEO). More often, however, these letters are significantly shorter, amounting to 3,000 words or less.
Annual reports usually advance a theme or concept that has been embraced by company management and/or its marketing wings. Catch phrases such as "poised for the twenty-first century" or "meeting the needs of the information age" can unify a company's annual report message. In addition, particular events or economic conditions of a given year may be incorporated into the themes advanced in an annual report. Companies also use milestone anniversaries—including industry as well as company anniversaries—in their annual reports. Promoting a long, successful track record is often appealing to shareholders and various audiences, for it connotes reliability and quality. Still other companies have developed a tried-and-true format that they use year after year with little change except updating the data. Whatever the theme, concept, or format, the most successful reports are ones that clearly delineate a company's strategies for profitable growth and cast the firm in a favorable light.
Target Audiences for Annual Reports
Current shareholders and potential investors remain the primary audiences for annual reports. Employees (who today are also likely to be shareholders), customers, suppliers, community leaders, and the community-at-large, however, are also targeted audiences.
EMPLOYEES. The annual report serves many purposes with employees. It provides management with an opportunity to praise employee innovation, quality, teamwork, and commitment, all of which are critical components in overall business success. In addition, an annual report can also be used as a vehicle to relate those company successes—a new contract, a new product, cost-saving initiatives, new applications of products, expansions into new geographies—that have an impact on its work force. Seeing a successful project or initiative profiled in the annual report gives reinforcement to the employees responsible for the success.
The annual report can help increase employee understanding of the different parts of the company. Many manufacturing locations are in remote areas, and an employee's understanding of the company often does not go beyond the facility where he or she works. An annual report can be a source for learning about each of a company's product lines, its operating locations, and who is leading the various operations. The annual report can show employees how they fit into the "big picture."
Employees also are often shareholders. So, like other shareholders, these employees can use the annual report to help gauge their investment in the company. In this case, they also realize that the work they are doing in making products or providing a service is having an impact on the value of the company's stock.
CUSTOMERS. Customers want to work with quality suppliers of goods and services, and an annual report can help a company promote its image with customers by highlighting its corporate mission and core values. Describing company initiatives designed to improve manufacturing processes, reduce costs, create quality, or enhance service can also illustrate a company's customer orientation. Finally, the annual report can also show the company's financial strength. Customers are reducing their number of suppliers, and one evaluation criterion is financial strength. They want committed and capable suppliers that are going to be around for the long term.
SUPPLIERS. A company's abilities to meet its customers' requirements will be seriously compromised if it is saddled with inept or undependable suppliers. Successful companies today quickly weed out such companies. By highlighting internal measurements of quality, innovation, and commitment, annual reports can send an implicit message to suppliers about the company's expectations of outside vendors. Sometimes an annual report will even offer a profile of a supplier that the company has found exemplary. Such a profile serve two purposes. First, it rewards the supplier for its work and serves to further cement the business relationship. Second, it provides the company's other suppliers with a better understanding of the level of service desired (and the rewards that can be reaped from such service).
THE COMMUNITY. Companies invariably pay a great deal of attention to their reputation in the community or communities in which they operate, for their reputations as corporate citizens can have a decisive impact on bottom line financial performance. A company would much rather be known for its sponsorship of a benefit charity event than for poisoning a local river, whatever its other attributes. Annual reports, then, can be invaluable tools in burnishing a company's public image. Many annual reports discuss community initiatives undertaken by the company, including community renovation projects, charitable contributions, volunteer efforts, and programs to help protect the environment. The objective is to present the company as a proactive member of the community.
This sort of publicity also can be valuable when a company is making plans to move into a new community. Companies seek warm welcomes in new communities (including tax breaks and other incentives). Communities will woo a company perceived as a good corporate citizen more zealously than one that is not. The good corporate citizen also will receive less resistance from local interest groups. The company's annual report will be one document that all affected parties will pore over in evaluating the business.
Reading an Annual Report
People read annual reports for widely different purposes and at dramatically different levels. Generalizations, however, are difficult. The stockholder with five shares might be as careful and discriminating a reader of an annual report as the financial analyst representing a firm owning one million shares.
It may require an MBA to understand all the details buried in an annual report's footnotes. Nevertheless, a good understanding of a company is possible by focusing on some key sections of the report.
COMPANY DESCRIPTION. Most companies will include a description of their business segments that includes products and markets served. Formats vary from a separate fold-out descriptive section to a few words on the inside front cover. A review of this section provides readers with at least a basic understanding of what the company does.
THE LETTER. Whether contained under the heading of Letter to Shareholders, Chairman's Message, or some other banner, the typical executive message can often provide some informative data on the company's fortunes during the previous year and its prospects for the future, though readers should always bear in mind that it is invariably in the executive's best interests to maintain a fundamentally upbeat tone, no matter how troubled the company may be. This is often the most widely read portion of the entire annual report, so business owners and managers should make a special effort to make it both informative and engaging.
MANAGEMENT'S DISCUSSION AND ANALYSIS (MD&A). This section can be dry and is often bursting with accounting jargon, but the MD&A nonetheless provides, in fairly succinct form, an overview of the company's performance over the previous three years. It makes a comparison of the most recent year with the year previous, and then compares this latter year with the year previous to it. It discusses sales, profit margins, operating income, and net income, as well as the principal factors that influenced business trends. Other portions discuss capital expenditures, cash flow, changes in working capital, and anything "special" that happened during the years under examination. The MD&A is also supposed to be forward-looking, discussing anything the company may be aware of that could negatively or positively affect results. An MD&A can be written at all different levels of comprehension, but business consultants generally urge companies to make the information—from balance sheets to management analysis—comprehensible and accessible to a general readership. This means forsaking jargon and hyperbole in favor of clear and concise communication.
FINANCIAL SUMMARY. Most companies will include either a five-, six-, ten-, or eleven-year summary of financial data. Sales, income, dividends paid, shareholders' equity, number of employees, and many other balance sheet items are included in this summary. This section summarizes key data from the statements of income, financial position, and cash flow for a number of years.
MANAGEMENT/DIRECTORS. A page or more of an annual report will list the management of the company and its board of directors, including their backgrounds and business experience.
INVESTOR INFORMATION. There almost always is a page that lists the company's address and phone number, the stock transfer agent, dividend and stock price information, and the next annual meeting date. This information is helpful for anyone wanting additional data on the company or more information about stock ownership.
Packaging the Annual Report
For most companies, large or small, the financial information and the corporate message are the most important aspects of an annual report. Many companies also want to be sure, however, that their targeted audiences are going to read and understand the message. This is less essential for privately owned businesses that do not need to impress or soothe investors, but they too recognize that disseminating a dry, monotonous report is not in the company's best interests. At the same time, turning the message over to a designer who is more intent on creating a visual, aesthetic monument than providing readers with easily found and coherent information is likely to have a similar negative effect.
The challenge for producers of annual reports is to disseminate pertinent information in a comprehensible fashion while simultaneously communicating the company's primary message. Many annual report readers spend very little time looking through a report, so the challenge is a substantial one. Thus, annual reports have in recent years become reminiscent of advertisements in their reliance on bold graphics and splashy colors. Indeed, in many ways the annual report serves as an advertisement for the company, a reality that is reflected in the fact that leading business magazines now present awards to company reports deemed to be of particular merit. In recent years, companies have also chosen to make their annual reports available in a variety of electronic media (web sites, CD-ROM, or diskette) that lend themselves to creative, visually interesting treatments.
Of course, the personality of the company—and perhaps most importantly, the industry in which it operates—will go a long way toward dictating the design format of the annual report. The owner of a manufacturer of hospital equipment is far less likely to present a visually dramatic annual report to the public than are the owners of a chain of suntanning salons. The key is choosing a design that will best convey the company's message.
Summary Annual Reports
Few major trends have jarred the tradition of annual reports, but one is the "summary annual report." In 1987, the SEC eased its annual reporting requirements. It allowed companies to produce a summary annual report, rather than the traditional report with audited statements and footnotes. Public disclosure of financial information was still required, but with the new rulings, filing a Form 10-K—provided it contained this information and included audited financial data and other required material within a company's proxy statement (another SEC-mandated document for shareholders)—met SEC requirements. Promoters of the summary annual report see it as a way to make the annual report a true marketing publication without the cumbersome, detailed financial data. Financial data is still included, but in a condensed form in a supporting role. Since its use was approved, however, the summary annual report has not gained widespread support.
In some respects, annual reports are like fashions. Certain techniques, formats, and designs are popular for a few years and then new ideas displace the old. Several years later, the old ideas are back in vogue again. Other formats are "classic," never seeming to go out of style or lose their power. A key to a successful annual report is not getting caught up in a trend, and instead deciding what works best for conveying the message.
Further Reading:
Bartram, Peter. "Are You Being Read?" The Director. November 1998.
Fulkerson, Jennifer. "How Investors Use Annual Reports." American Demographics. May 1996.
Parks, Paula Lynn. "Satisfy Stockholders." Black Enterprise. April 2000.
Samuelson, Robert J. "Close to the Lunatic Edge: Corporate Annual Reports Often Tell Us More Than Their Authors Know or Intend." Newsweek. April 21, 1997.
See also: Balance Sheets; Financial Statement; Income Statement
