Use the notes to check revenue recognition, segment results, lease liabilities and debt terms.
Open your chosen company's annual report and find the point where the primary statements end and the notes begin. Count the pages of each. Larkspur is a made-up company that makes semiconductor equipment parts and coatings, and all of its figures here are invented for the example. Its annual report has six pages of primary statements and seventy pages of notes. Most readers stop at the primary statements, even though in nearly every report the notes run much longer.
Reading only the primary statements is like reading a football season's scores without knowing who played whom. The notes explain how each number was built, what it includes, what it leaves out and what conditions are attached to it. For almost any company, four notes change the picture: revenue, segments, leases and debt.
The revenue note sets out the company's approach to revenue recognition, which is the point at which a sale counts as revenue. Singapore companies follow SFRS(I) 15, and other places have equivalent standards. Under SFRS(I) 15, revenue is recognised when control of the goods or services passes to the customer. For most product sales that happens on delivery or acceptance. On long contracts, revenue can be recognised over time as the work is done, based on an estimate of how far along the contract is.
First, find which method the company uses, because each one carries a different risk. Over-time recognition depends on estimates of progress and total cost. If those estimates change, profit can move while cash stays the same, so note how much of revenue rests on them. With recognition at delivery, a company can pull revenue into a period by shipping early or by offering extended payment terms near the year end, so look for early shipments or longer payment terms in the last months of the year.
Larkspur's revenue note is on page 104. Most of its revenue is recognised when the customer accepts the parts, and a small amount of tooling work is recognised over time. This is the simpler of the two cases. Because revenue is booked mainly on acceptance, it should track shipments closely. Module 7 checks whether receivables grow in step with revenue, since a jump in receivables can mean sales were booked before customers were ready to pay.
The segment note breaks revenue, operating profit and often assets down by business line and by region. It uses the same divisions management uses to run the company, and it is often the most revealing page in the report. Put revenue, operating profit and assets for each segment side by side, then work out which part earns the money and which part soaks up the capital.
At Larkspur, semiconductor equipment parts brings in 85% of revenue and almost all of operating profit. This segment earns the profit, and it needs ordinary capital spending to keep growing. Coatings brings in 15% of revenue and runs close to break-even. It consumed capital through an acquisition and earns very little on that capital. Coatings also carries most of Larkspur's S$30 million of goodwill, which first appeared in lesson 6.3, "The auditor's report, key audit matters and going-concern wording".
The geographic split in the same note gives a second view, showing where revenue comes from, and lesson 4.3, "Semiconductor supply chains and export controls", used that split to find where revenue comes from.
Before 2019, many companies kept operating leases off the balance sheet and recorded the rent as an expense. IFRS 16, which is SFRS(I) 16 in Singapore, brought most leases onto the balance sheet. The company now shows a right-of-use asset on one side and a lease liability on the other. The liability equals the present value of future lease payments. In place of rent, the lease expense is now depreciation on the right-of-use asset plus interest on the lease liability.
Because of this change, lease-heavy businesses such as retailers, airlines and companies on leased land look more indebted than they used to. Their operating profit and EBITDA are also higher, because rent no longer sits above those lines. Lesson 7.4, "Cash flow statement and free cash flow", shows how lease payments can also flatter operating cash flow. When you compare two companies, check whether each figure is before or after leases, and whether a ratio counts lease liabilities as debt.
In the lease note, find total lease liabilities and the maturity table, then compare the liabilities with total assets. Larkspur has S$20 million of lease liabilities, mostly for factory land. Against total assets of S$410 million that is small but not nothing, and the maturity table shows about S$4 million of principal due each year.
The borrowings note lists every loan or bond with its currency, its interest rate, whether that rate is fixed or floating, its maturity and any security. A separate liquidity table usually shows when the cash payments fall due. Read the note for three things:
the next large repayment, and whether the company has the cash or facilities to meet it how much of the debt is at floating rates, which matters when rates rise the covenants, and how close the company is to them; covenants are conditions lenders impose, such as a maximum ratio of net debt to EBITDA or a minimum interest cover
If a company breaches a covenant, the lender can demand early repayment. A company whose debt was otherwise manageable can then be forced to sell assets or raise equity at a bad price. Rights issues often start with this kind of debt pressure, as lesson 5.5, "Corporate actions: rights issues, placements, buybacks and splits", describes.
Larkspur has S$60 million of bank loans, all at floating rates. S$10 million is due within a year, and a S$40 million term loan matures in three years. Its covenant requires net debt below three times EBITDA. Net debt including leases is about S$20 million and EBITDA is S$80 million, which leaves Larkspur far inside that limit. The item to watch is the term loan, because refinancing S$40 million in a downturn costs more than refinancing it in a good year.
From your chosen company's notes, record the revenue policy, the most profitable segment, total lease liabilities and the next large debt maturity, and write the page number beside each one.
From your chosen company's notes, write down the revenue policy, the most profitable segment, total lease liabilities and the next large debt maturity.
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