12.7. Dealing with Information Overload

As a general rule, the larger a business, the longer its annual financial report. I've seen annual financial reports of small, privately owned businesses that you could read in 30 minutes to an hour. In contrast, the annual reports of large, publicly owned business corporations are typically 30, 40, or 50 pages (or more). You would need two hours to do a quick read of the entire annual financial report, without trying to digest its details.

If you did try to digest the details of an annual financial report, which is a long, dense document not unlike a lengthy legal contract, you would need many hours (perhaps the whole day) to do so. (Also, to get the complete picture, you should read the company's filings with the SEC in conjunction with its annual financial report. Tack on a few more hours for that!) For one thing, there are many, many numbers in an annual financial report. I've never taken the time to count the number of numbers in an average annual financial report, but I can guarantee there are at least hundreds, and reports for large, diversified, global, conglomerate businesses must have over a thousand.

12.7.1. Browsing based on your interests

How do investors in a business deal with the information overload of annual financial reports? Very, very few persons take the time to plow through every sentence, every word, every detail, and every number on every page — except for those professional accountants, lawyers, and auditors directly involved in the preparation and review of the financial report. It's hard to say how most managers, investors, creditors, and others interested in annual financial reports go about dealing with the massive amount of information — very little research has been done on this subject. But I have some observations to share with you.

An annual financial report is like the Sunday edition of a large city newspaper, such as The New York Times or the Chicago Tribune. Hardly anyone reads every sentence on every page of these Sunday papers, much less every word in the advertisements — most people pick and choose what they want to read. They browse their way through the paper, stopping to read only the particular articles or topics they're interested in. Some people just skim through the paper. Some glance at the headlines. I think most investors read annual financial reports like they read Sunday newspapers. The complete information is there if you really want to read it, but most readers pick and choose which information they have time to read.

Annual financial reports are designed for archival purposes, not for a quick read. Instead of addressing the needs of investors and others who want to know about the profit performance and financial condition of the business — but have only a very limited amount of time available — accountants produce an annual financial report that is a voluminous financial history of the business. Accountants leave it to the users of annual reports to extract the main points. So financial statement readers use relatively few ratios and other tests to get a feel for the financial performance and position of the business. (Chapters 13 and 17 explain how readers of financial reports get a fix on the financial performance and position of a business.)

12.7.2. Recognizing condensed versions

Here's a well-kept secret: Many public businesses and nonprofit organizations don't send a complete annual financial report to their stockholders or members. They know that few persons have the time or the technical background to read thoroughly the full-scale financial statements, footnotes, and other disclosures in their comprehensive financial reports. So, they present relatively brief summaries that are boiled-down versions of their complete financial reports. For example, my retirement fund manager, TIAA-CREF, puts out only financial summaries to its participants and retirees. Also, AARP issues condensed financial reports to its members.

Typically, these summaries — called condensed financial statements — do not provide footnotes or the other disclosures that are included in the complete and comprehensive annual financial reports. If you really want to see the official financial report of the organization, you can ask its headquarters to send you a copy (or, for public corporations, you can go to the EDGAR database of the SEC — see the sidebar "Financial reporting on the Internet").

12.7.3. Using other sources of business information

Keep in mind that annual financial reports are only one of several sources of information to owners, creditors, and others who have a financial interest in the business. Annual financial reports, of course, come out only once a year — usually two months or so after the end of the company's fiscal (accounting) year. You have to keep abreast of developments during the year by reading financial newspapers or through other means. Also, annual financial reports present the sanitized version of events; they don't divulge scandals or other negative news about the business.