Key sections help digest annual reports

By Brad Foss
Associated Press

Q. With corporate annual reports getting thicker every year, it is harder to find time to read them. What are the most important areas to keep an eye on?

A. Any selective look at a 10-K filed with the SEC is going to be just that, increasing the chance that critical data will be overlooked.

That said, an investor who investigates at least some portion of an annual report is likely to gain insight — particularly in the area of corporate strategy — not disclosed in quarterly financial statements.

No other section of a 10-K is more illuminating for this purpose, experts say, than the management discussion and analysis. The qualitative component of an annual report, it gives investors details about everything from market risks and cash reserves to accounting policies and ongoing litigation.

"If I was going to spend just 10 minutes with a 10-K, I'd read the management discussion and analysis," said David Hardesty, a Larkspur, Calif.-based accountant and author of "Corporate Governance and Accounting Under the Sarbanes-Oxley Act of 2002."

With regulatory scrutiny heightened in the wake of corporate accounting scandals, companies have become more forthcoming.

"On balance, it probably is getting a little better," said Mike Starr, managing partner of strategic services at Grant Thornton LLP, a Chicago-based accounting firm. Yet far too much of the MD&A is just "boilerplate," he said.

"If you read a disclosure that doesn't make sense, then that's a big red flag," Starr said, echoing a point often made by Warren Buffett, the billionaire who heads the Berkshire Hathaway investment company.

Experts say the key to analyzing the explanations in the MD&A is to cross-reference them with financial statements in the report.

Nancy Newman-Limata, a partner at PricewaterhouseCoopers, said she focuses on the company's cash position. "I flip between what management says about how liquid they are ... and then look at the cash-flow statement. ... to see if the two marry up nicely," she said.

Other areas that may yield clues about a company's health deal with pensions, litigation and changes in accounting policy, she said.

"After the accounting scandals and audit failures of the past few years, companies are providing even more information to boost investor confidence," said David Zion, an accountant at Credit

Suisse First Boston in New York, in a recent report, "10-K Checklist."

• On the Web: www.nysscpa.org/sound_advice/archive.htm