Knowing that most people won't spend the time to read all the way through the annual financial report, many companies summarize their numbers in various ways. The two most common ways to summarize are to highlight the financial data presented in the financial statements and to summarize some key information in the notes to the financial statements. But beware: Most summaries highlight the good news and skip over the bad.
Find the highlights
The highlights to the financial data summarize the financial results for the year being reported. Typically, this summary is called the financial highlights, but companies can be creative because this section isn't a required part of the report. And because the highlights aren't required, they're not always presented according to GAAP rules, so don't count on their accuracy.
You usually find the financial highlights at the front of the annual report, after the letter from the CEO and chairman of the board. Some companies include them inside the annual report's back cover.
You frequently find financial highlights at the front of the annual report, designed in a graphically pleasing way. Most companies show either a 10-year or 11-year summary that doesn't include much detail but allows you to see the firm's growth trends.
Although this type of summary can be a good historical overview, don't count on it. Instead, do your own research of the company's financial history to be sure that you're aware of both the good and the bad news. Remember that even outstanding companies have some bad years that they want to gloss over.
Read the notes
The notes to the financial statements is the section where you find any warts on a company's financial record. The notes are a required part of the annual report, and they give you the details behind the numbers presented in the financial statements. Companies like to hide their problems in the notes; in fact, most companies even print this part of the annual report in smaller type.
Most of the details in the notes discuss the impact that the following business aspects may have on the company's future financial health:
Accounting methods used
Changes to accounting methods
Key financial commitments that can impact current and future operations
Lease obligations
Pension and retirement benefits
If any red flags pop up in a company's annual report, this part is where you can find the financial details and explanations. The auditors’ report probably highlights any potential problems and red flags that you want to search for in the notes. You may also find problems mentioned in the MD&A section, but the notes section probably covers the full explanations for these problems in greater detail.
Don't get turned off by the visually unpleasing presentation. The notes to the financial statements is one of the most critical parts of the annual report.