Reading the footnotes
The financial statements are four pages. The notes are eighty. Everything that required a decision is explained in the eighty.
A set of accounts has two parts. The statements give the numbers. The notes explain how each number was arrived at, what assumptions it rests on, and what obligations exist that no number captures. The second part is longer for a reason.
The notes that repay the time
- Significant accounting policies. Usually the first note. How revenue is recognised, how assets are depreciated, how inventory is valued. Read it once for a new company, then only when it changes — and a change is the point of reading it.
- Segment information. Revenue and profit by division and region. Often the most informative page in the document. See segment reporting.
- Debt. Maturities, interest rates, fixed versus floating, and covenants. Tells you when refinancing is due and what happens if a ratio is breached.
- Commitments and contingencies. Obligations not recognised on the balance sheet: litigation, guarantees, purchase commitments.
- Tax reconciliation. Why the effective rate differs from the statutory one, quantified line by line.
- Share-based payments. How much, to whom, on what vesting conditions. See stock-based compensation.
- Related parties. Short, and occasionally the most revealing page in the report.
- Subsequent events. Anything material between the balance sheet date and publication. By definition the most recent information in the document.
The technique
A single year's policy note is a statement of method and tells you very little. The same note across three years tells you what changed, and changes are where the information is: a lengthened asset life, a revised revenue policy, a new pension assumption, a provision quietly released. None of these are hidden — they are disclosed precisely as required, in language designed not to draw attention.
Contingent liabilities
An obligation is recognised on the balance sheet when it is probable and can be estimated. Below that threshold, it is disclosed in a note and nowhere else. Litigation, environmental obligations, guarantees given on behalf of other entities, tax disputes.
So a company can face a material claim that appears in no financial statement line. The note is the only place it exists, and the language is calibrated: 'remote', 'possible', and 'probable' are technical terms, not casual ones.
Pensions
For older industrial companies the defined-benefit pension note can dominate the balance sheet. The deficit or surplus depends on a discount rate, an assumed return, and mortality assumptions. Small changes to any of them move the number enormously, and the note discloses the sensitivity.
Reading efficiently
- Search the document for 'change in accounting', 'reclassified' and 'restated'. Three searches, thirty seconds, and they find most of what matters.
- Read the key audit matters first, then read the notes the auditor identified. They have already done the triage.
- Compare this year's note to last year's side by side. Differences jump out; absolute values do not.
- Read the subsequent events note early — it is the newest information in the filing.
Everything above is in a document any investor can download the day it is published. The advantage available here is not access to information. It is the willingness to read what has already been handed to you.