During Diwali, I encountered an enticing offer that initially sparked my excitement. However, my enthusiasm was reduced when I noticed a small asterisk (*) accompanying the offer. After I looked into the additional terms and conditions of the offer, it lost its initial appeal. This experience is similar to situations in our daily lives, where supplementary details are essential to comprehend the underlying information. This principle is also applicable in the realm of investments; acquiring more data about a company can significantly help in decision-making. In the context of financial statement analysis, such additional insights are often found in a section known as "Notes to Accounts”.
Generally, a financial statement comprises five key sections: the Balance Sheet, Statement of Profit and Loss, Statement of Cashflows, Statement of Changes in Equity, and Notes to Accounts. I have already discussed about Statement of Cashflows in my previous blog. Today let us understand more about Notes to Accounts.
While the Balance Sheet provides insight into a company's financial position and the Profit and Loss statement reveals its financial performance, these sections lack details on the calculations involved. The Notes to Accounts section is like an annexure to the other sections. It serves to elucidate the intricacies of the calculations and the rationale behind the presented figures. In financial statements, these notes unveil the specific assumptions made by accountants during the preparation of the income statement, balance sheet, statement of changes in financial position, or statement of retained earnings. This comprehensive explanation is crucial for a thorough comprehension of the documents.
Typically, the initial notes in this section elucidate the "basis for accounting," clarifying whether cash or accrual rules were employed in document preparation and detailing the methods used for reporting amortization/depreciation expenses. Subsequent notes delve deeper into the calculations, providing the reader with the necessary information for a more profound analysis.
In addition to furnishing supplementary information, details, and clarification concerning items, amounts, and transactions, these notes may include relevant details not explicitly disclosed in the financial statements. Information such as contingent liabilities, commitments, related party transactions, segment reporting, significant events occurring after the reporting date, etc. is crucial for investors seeking a more comprehensive understanding of the company's situation.
The benefit of these Notes to Accounts can be summarised in a few points:
· Notes improve financial statement quality and transparency.
· They explain the basis behind reported figures.
· Notes aid in assessing business performance, financial position, and risks.
· Notes provide information which might not be reported in financial statements but can be very important for the investors
· Separating notes from the rest of the financial statements avoids clutter in the annual report.
Though Notes to Accounts is important, it also has a few disadvantages. Understanding the notes and disclosure requirements in large companies can be challenging for non-specialists without a solid grasp of accounting practices due to their complexity. Also, in the quest for clarity, vital information often gets buried within an overwhelming volume of extensive notes. Retrieving essential details from this abundance becomes a daunting task, demanding expertise in the subject.
In conclusion, despite some drawbacks, Notes to Accounts remain a crucial component of financial statements. Reading these notes is essential for obtaining a comprehensive understanding of the financial statement.
If you would love to understand and learn more about such topics, make sure to check out my course on Fundamental Analysis. Until next time!