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Guide · May 13, 2021

Annual report reading guide for business buyers

By the Best Asian Businesses editorial team

This annual report reading guide gives you a fast order of attack. Read the auditor's opinion first, then the cash flow statement, then the notes, and last the related party items. That path takes about an hour and tells you more than the glossy front pages do.

Business buyers often skim an annual report for the profit figure and stop. Profit is only one number. A supplier can show profit and still run out of cash. The sections below show where the warning signs sit.

Start with the auditor's opinion

Turn to the independent auditor's report. It is usually a few pages long and sits near the financial statements. Find the sentence that says whether the statements give a true and fair view. An unmodified opinion is the clean result. It means the auditor found the statements prepared, in all material respects, under the stated reporting framework.

Look for these words: qualified, adverse, disclaimer, or emphasis of matter. Each one is a flag. A qualified opinion means the auditor disagreed with, or could not check, something specific. An emphasis paragraph points to a note the auditor wants you to read. A section called the basis for opinion follows the opinion itself and explains the standards used.

Also check who signed, the date, and which accounting standards the company used. In Singapore, the Companies Act requires directors to see that statements follow the accounting standards and give a true and fair view, and to lay them before the company at the annual general meeting.

Sources: IAASB, ISA 700 (Revised); Singapore Statutes Online, Companies Act 1967, section 201.

Read the cash flow statement next

The cash flow statement shows real money in and out. It splits cash into three groups: operating, investing and financing. The operating line matters most for a buyer. It shows whether the core business produces cash.

Compare operating cash flow with profit. If profit is high and operating cash is low or negative for several years, ask why. Slow-paying customers and piling stock are common causes. Both can strain a supplier's ability to deliver your order.

Then look at financing. Large new borrowing can fund growth, but it can also cover a cash gap. Check the closing cash balance against the balance sheet. The standard requires companies to show what counts as cash and to reconcile it, so the numbers should match.

Sources: IFRS Foundation, IAS 7 Statement of Cash Flows.

Go into the notes

The notes are part of the financial statements. They are not an appendix to skip. Many facts that change a buying decision live here, and they are often in small type.

Scan the notes for four things:

  • Accounting policies, especially how and when the company records revenue.
  • Borrowings, with repayment dates and any security given over assets.
  • Commitments and contingent liabilities, such as court cases or guarantees given for others.
  • Events after the reporting date, which can show a sudden loss or deal.

If a note is vague, that is information too. A clear note names amounts and dates. A vague one hides them.

Sources: IFRS Foundation, IAS 1 Presentation of Financial Statements; IFRS Foundation, IAS 10 Events after the Reporting Period; Singapore Statutes Online, Companies Act 1967, section 201.

Check related party items

A related party is a person or firm close to the company, such as a director, a major shareholder, or a business they control. Deals with these parties may not be on market terms. That does not make them wrong. It makes them worth reading.

The standard requires a company to describe each relationship and to disclose the transactions, the balances owed and any commitments. It must also report the pay of key management. Look at the size of these amounts against revenue. If loans to a director are large, or most sales go to one affiliated buyer, note it in your file.

For companies listed on the Singapore Exchange, the listing rules add more. The annual report must show details of interested person transactions and of material contracts involving the chief executive, directors or controlling shareholders. If there are none, the report must say so.

Sources: IFRS Foundation, IAS 24 Related Party Disclosures; SGX Rulebook, Rule 1204.

Check the audit committee and auditor fees

Listed companies must also disclose what they paid their auditors. The split between audit fees and other services shows whether the auditor may be too close to management. The audit committee must say it reviewed the non-audit work and that, in its view, independence is intact.

The same rules ask the committee to comment on internal controls and the internal audit function. Read those paragraphs for plain statements, not stock phrases.

Sources: SGX Rulebook, Rule 1204.

A one page checklist

  • Is the opinion unmodified, and who signed it?
  • Does operating cash flow track profit over three years?
  • Do the notes show borrowings, commitments and later events?
  • Are related party amounts small next to revenue?
  • Are auditor fees split and explained?

An annual report is a record, not a guarantee. Use it with trade references, site visits and your own contract terms. This is general information only. For a deal that rests on a company's accounts, ask a qualified accountant or lawyer.

Sources