Why HR should study the annual report (Guest commentary)

Report brings business strategy into focus
By Michael Thomsett
|Canadian HR Reporter|Last Updated: 01/11/2007

Taking on the added role of business strategist is a daunting task for an HR practitioner. But there’s a cheat sheet. The corporate annual report contains information every HR practitioner needs to know.

This by no means suggests perusing the annual report is going to quickly convert HR practitioners to experts in high finance. But it will improve appreciation of the business model under which the company operates and help bring the business strategy into focus.

Simple profitability

The first and last word in any business model is profitability. Financial people expect positive growth year after year, so the first question an HR practitioner needs to ask is “What is my company’s profitability?”

A quick examination of TransCanada Corporation reveals a five-year growth trend in both revenues and net profits (see

table

). This is a rather straightforward summary. No accounting expertise is required to understand that the lines of revenues and net profits were both moving upward each year. Simply creating profits and improving upon them each year is perhaps the easiest and the best measure of management’s success with its business model.

Corporate themes and beliefs.

What does management believe and how does it promote the stated belief system? Is the model ruthless and competitive, or is the company more concerned with creating and maintaining good relations with all of its resources such as customers, employees, vendors and investors?

The promotion of the corporate culture is expressed in the narrative sections of the annual report, specifically in the letter from the chairman or CEO. This culture may take many forms, with emphasis on shareholder profits, social responsibility or benefits provided to employees. In its 2005 annual report, General Motors emphasized employee and retirement benefits, pointing out that it provides more dollar value in benefits than any other company. The letter from the CEO claimed that GM retirement payments went to 3.2 retirees and surviving spouses for every actively employed individual.

Competitive position.

The easiest way to compare and judge one company against another involves a two-part test. First is profitability over a period of years. Second is relative size of the company, measured by revenue and profit dollars. TransCanada’s 2005 results showed more than $5 billion in revenues. This sort of comparison is quite revealing. In the retail sector, a comparison between Wal-Mart and Canadian Tire demonstrates that both companies are well-managed, profitable and growing. However, Wal-Mart’s revenues are about $300 billion US per year and net profits $11 billion US. Canadian Tire’s range is far smaller, with $7.8 billion Cdn in revenue and about $330 million Cdn in net profits.

This does not mean “bigger is better.” But volume is an important consideration because a big part of competitiveness involves geographic influence. While profitability is the ultimate financial goal, competitiveness does and should involve questions of volume in both revenues and profits.

Annual reports also reveal a company’s major competitors. As part of a business strategy, HR practitioners are wise to size up their company’s annual report with those of other companies in the same market. It is fast, easy and free to locate annual reports online. Visit the Toronto Stock Exchange at www.tsx.com, click on “About TSX Group” and select “Listed Company Directory” from the drop-down menu to find links to pages for any listed company.

Transparency.

There are significant differences between compliance and transparency; and HR practitioners who recognize this difference will be able to better understand how some annual reports fail to provide investors what they need and deserve.

To many in the accounting business, “full disclosure” is the equivalent of transparency. To regulators, a company’s compliance with all disclosure rules is satisfactory. But for investors as well as for non-accounting executives, meeting the rules is often a far cry from actual transparency.

To meet this higher standard, the HR practitioner may question some assumptions made in reporting methods. If HR practitioners are able to point to examples of transparency in their own corporate annual report, it is a significant and important step, even if only because it means that a non-accountant is able to comprehend the significance of market changes, competition, risks for investors and career growth potential for employees.

Transparency also extends to how corporations evaluate, report and describe their packages of employee benefits including post-retirement and survivor benefits. The case of General Motors makes this point. It is not adequate to disclose the numbers in expense and liability levels; transparency enables the HR practitioner as well as others to truly see and comprehend the significance of those dollar values.

The ‘reasonable person’ test

The “reasonable person” test can and should be applied to the annual report and the information it provides. How does the report express profitability and what trends are underway? What are the major corporate themes and beliefs (its culture) and how are these ideas expressed? What is the company’s competitive posture (leader or follower) and what trends are underway competitively? Finally, how does the annual report enable the HR practitioner to better convey the important information about a company? And, when reviewing other annual reports, how does the company compare to its competitors?

The HR practitioner who is able to take these points and translate them into a means for improving their own communication skills and to further the interests of the company, will become more effective. No one outside of the accounting realm needs to become an expert at what the numbers reveal, but everyone may benefit by improving comprehension of the four key areas of knowledge that the annual report provides.


By the numbers

TransCanada's five-year growth

Year Revenues (millions)Net profits (millions)
2001$3,307$464
2002$3,337$515
2003$4,125$617
2004$4,239$813
2005$5,234$1,033

Michael C. Thomsett is author of Annual Reports 101, published by Amacom Books. He has written more than 60 books on business and financial topics. He lives in Washington state.

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