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Communication with shareholders and stakeholders through financial report

The company mainly communicates with its shareholders and other stakeholders through its financial report. Therefore the main objective of a financial report is to offer information which is useful to current and potential investors for decision making (FASB).

Financial statements alone cannot give a balanced and understandable view of the company’s position and prospects. Therefore a variety of narrative reports have been included in the Group annual report, which provides additional information that are non- financial on the company’s stance, performance and prospects (O’Regan, 2001). This narrative section is not audited by auditors as the financial section, but still many users rely on this to evaluate the position of the company. Therefore, the company would often use graphics and other distraction methods to manipulate the financial figures in order to make the report look more attractive to the current and potential investors (Penrose J.M., 2008).

Use of colour and graphics

“The graphic designer of the annual report can manipulate the perception of the data in a graph ...” (Penrose.J. 2008).

As mentioned in the introduction, firms tend to use distraction methods so as to make the narrative report look more attractive. Pennon Group is no different than the others. There seem to be several attempts made in order to distract the reader.

A very obvious instance is the usage of key performance indicators at the top of the page. On most pages KPI’s are given as highlights, often out of context in very attractive graphics. This would definitely distract the respective reader from reading the long paragraphs.

Another method used by the Group is the usage of graphs mostly on the left page of the report. This distracts readers because it is often the first thing they would see. In other instances when two graphs are provided for comparison often the axis of both graphs are not the same, which can mislead readers. Furthermore gridlines are not available in these graphs, causing readers to assume the figures.

The report also seems to have used a lot of colours and attractive graphics in most pages. Often almost a quarter of the pages are full of graphics. Because the graphics look attractive, the readers might assume that the company had delivered a strong performance financially during the year.

The Canadian Institute of Charted Accountants (2008) points that using graphs would help focus interest, attract, help understand and save time in analysing data. The narrative section of Pennon Group consists of many types of graphics. Column charts and pie charts appear be the most common out of the rest. Also a wide range of pictures, designs and colours are used to highlight other points.

The graphs provided are quite easy to interpret. Often Different colours are used to distinguish between time periods. Furthermore the use of blue and green to distinguish between the two subsidiaries proves to be quite effective.

The graphics provided are also quite reliable, as the data it represents agrees with the underlying information. However most of these graphics are irrelevant to the data it represents. For instance instead of using a column chart to represent turnover, it would have been more appropriate to use a line chart, as shown below.

The current and potential investors will have very little trouble in evaluating the performance, as the graphics are comparable between two pieces of information. Previous year’s figures are given along with the current year’s figures, making comparison effortless.

The usage of graphics bypasses the language barrier, and therefore enabling non-English speaking investors to comprehend better. Because often the inclusion of technical terms would confuse most readers. In similar instances these graphs make sure to convey the intended message.

Use of Language

Pennon Group has worded sentences carefully when dealing with bad news that would upset investors. One such instance is when the chairman mentions that one of the subsidiaries of the Group, Viridor Limited “had delivered a strong financial performance in a very challenging environment”. By using the words “challenging environment” Pennon Group tries to make Viridor Limited look better in the eyes of the investors. This would also imply that Viridor Limited had performed reasonably well during the year.

There are also instances where the words “uncertain global economic background” had been used in the narrative report to describe low or declining performances.

Also on one occasion the report mentions that “operating profit has increased despite the decrease in demand”. By mentioning that the “operating profit has increased”, the fact that the demand has actually decreased will not be highlighted.

What they say....

The respective users of the reports may not be interested in all those information that have been presented in narrative reports and would rather emphasize only on relevant information they may need to aid their decision making. Therefore the Pennon Group’s narrative report shows two key characteristics as illustrated in the FASB exposure draft, relevancy and faithful representation.

The information presented in Pennon Group’s annual report 2009 seems relevant to existing and potential investors. Adequate useful details about the performance and the financial position of the Group during the current year have been given. Also a summary which includes many key performance indicators (KPI’s) is provided. These were also presented quite accurately, and are the same as in the financial statements, and were not misleading. This also saves the trouble of flipping through the whole report looking for information.

However, the above two key characteristics would not suffice in the interpretation of data. Different users may have different interests in these reports. Therefore it is essential to enhance these fundamental qualitative characteristics to be of more use to the users.

The FASB exposure draft of May 2008 identifies four more characteristics that could enhance the usefulness of the narrative reports, namely, Comparability, Verifiability, Timeliness and Understandability.

2.1.2 Comparability

FASB exposure draft of May 2008 points that comparability enables users to identify similarities and differences and evaluate the Group reasonably accurately.

The information given in the Pennon Group’s narrative report was fairly easy to compare with figures of the past. Any increase or decrease during the year was explained with comparison to previous years. Also due to the fact that Pennon Group prepares their accounts according to relevant accounting standards it makes it fairly straight forward to compare with other similar companies in the industry and get an overall idea about how the Group is performing.

2.1.3 Verifiability

John. M. Penrose exemplifies that narrative reports are not subject to be audited. Although it is not audited the information provided by Pennon Group appears to be presented in a reliable manner, and the information agrees with the underlying data.

2.1.4 Timeliness

Pennon Group has only presented information in the narrative report that is useful for the users and that will most probably influence their decision. Irrelevant information about previous years was not highlighted in the narrative report. Although it would have been of help to the users of the report if a line chart was included which would show the gradual increase in revenue during the past years.

2.1.5 Understandability

The information provided in the narrative report was quite straightforward. The information is given in simple English with very little technical terms. Also the fact that information is categorized under relevant subheadings makes it even easier to interpret. The use of colours was also used to distinguish between the two main subsidiaries. The frequent use of paragraphs to highlight different points was very useful to users when looking for specific details. Also the inclusion of numerical figures to support the information given increases the level of understandability.

What they don’t say....

The narrative section of Pennon Group provides a vast amount of information to various users. However there appears to be certain vital points which were not highlighted within the report.

The narrative report has emphasized on the profit before tax, but has failed to highlight the fact that profit after tax has been on a decline. This is shown in the financial report, but not in the narrative report.

Another vital piece of information withheld from the readers, is the fact that the increase in Earnings per share by 6% every year is in fact a company policy only till 2010. With the reducing profit after tax it is hard to guarantee such an increase after 2010. Potential and current investors reading the report might get a wrong impression and this may cloud their judgement.

Summary

In brief, the purpose of a narrative report is to provide additional information to investors to aid them in their decision making. The narrative section of Pennon Group was able to achieve this by providing information which was useful from a shareholders point of view.

The information provided shows characteristics of clarity, understandability and effectiveness which can be interpreted by a current or potential investor even with a minimum accounting knowledge. Furthermore, the information rarely varies from the truth giving a fair and balanced view on the company’s stance. To summarize, it can be accurately concluded that the information provided in the narrative statement makes sure it provides the user of the report the intended message, with minimum deviations.


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