Reading Financial Reports of Private Versus Public Businesses
Knowing the difference between financial reports of private and public companies is important for accounting. Public companies make their financial reports available to the public at large; they don’t limit distribution only to their present shareowners and lenders. In contrast, private companies generally keep their financial reports private — they distribute their financial reports only to their shareowners and lenders.
Even if you were a close friend of the president of a private business, the president probably wouldn’t let you see a copy of its latest financial report. You may as well ask to see the president’s latest individual income tax return. (You’re not going to see it, either.)
Although accountants are loath to talk about it, the blunt fact is that many private companies simply ignore some authoritative standards in preparing their financial reports. This doesn’t mean that their financial reports are misleading — perhaps substandard, but not seriously misleading. In any case, a private business’s annual financial report is generally bare bones. It includes the three primary financial statements (balance sheet, income statement, and statement of cash flows) plus some footnotes — and that’s about it.
Some private company financial reports don’t even have a letter from the president. In fact, some financial reports of private businesses (mostly very small companies) that don’t include a statement of cash flows, even though this financial statement is required according to U.S. GAAP.
Public businesses are saddled with the additional layer of requirements issued by the Securities and Exchange Commission. (This federal agency has no jurisdiction over private businesses.) The financial reports and other forms filed with the SEC are available to the public at the SEC’s website. The anchor of these forms is the annual 10-K, which includes the business’s financial statements in prescribed formats, with many supporting schedules and detailed disclosures that the SEC requires.
Most publicly owned businesses present very different annual financial reports to their stockholders compared with their filings with the SEC. A large number of public companies include only condensed financial information in their annual stockholder reports (not their full-blown and complete financial statements). They refer the reader to their more detailed SEC financial report for specifics. The financial information in the two documents can’t differ in any material way. In essence, a stock investor can choose from two levels of information — one quite condensed and the other very technical.
A typical annual financial report by a public company to its stockholders is a glossy booklet with excellent art and graphic design, including high-quality photographs. The company’s products are promoted, and its people are featured in glowing terms that describe teamwork, creativity, and innovation — you get the picture.
In contrast, the reports to the SEC look like legal briefs — there’s nothing fancy in these filings. The SEC filings contain information about certain expenses and require disclosure about the history of the business, its main markets and competitors, its principal officers, any major changes on the horizon, the major risks facing the business, and so on.
Professional investors and investment managers definitely should read the SEC filings. By the way, if you want information on the compensation of the top-level officers of the business, you have to go to its proxy statement.
Public corporations solicit their stockholders’ votes in the annual election of persons to sit on the board of directors and on other matters that must be put to a vote at the annual stockholders’ meeting. The communication for soliciting votes from stockholders is called a proxy statement — the reason being that the stockholders give their votes to a proxy, or designated person, who actually casts the votes at the annual meeting according to the instructions of the stockholders.
The SEC requires many disclosures in proxy statements that are not found in annual financial reports issued to stockholders or in the business’s annual 10-K. For example, compensation paid to the top-level officers of the business must be disclosed, as well as their stock holdings. If you own stock in a public corporation, take the time to read through the annual proxy statement you receive.