June 19, 2017

Taking the Fear Out of Reviewing a 10-K

Ipsa scientia potestas est. This phrase came from Sir Francis Bacon in Bacon’s Mediationes Sacrae in 1597.  It means “Knowledge itself is power,” and it offers valuable guidance to technology sales professions.

For a B2B sales executive, these words especially apply to reviewing a prospect’s 10-K.  In this short discussion, I will demystify the effort it takes to review and interpret a prospect’s financial statements and provide a short overview of the structure of an annual report and the 10-K.

Annual Report and 10-K

Public companies file many financial statements filed throughout the year. Once a year US public companies are required to file a Form 10-K.  They may or may not also publish an Annual Report. These two documents are slightly different. The Annual Report is created for investors and customers (easier to read and with a bit more “rah rah!”). The 10-K is more rigid and follows SEC guidelines. In addition, once a quarter companies file a 10-Q. This document is a progress report to let investors know how they are doing against stated goals or prior results and to report quarterly financial results. In between these annual and the quarterly SEC filings they file all sorts of other forms you likely won’t need to worry about.

A cover sheet to a 10-K Form

You can find a prospect’s financials in several places. An obvious choice is to Google them, or you can usually look them up in the Investor relations section of their website. Another choice to visit the U.S. Security and Exchange commission’s website and enter the company stock symbol or name.  All filings for a US-based public company will appear here.

When available, I like to start with the Annual Report and more specifically the Letter to the Shareholders if one has been published. This communication from the CEO usually begins with how they did in the previous year and ends with a look to the future. It usually contains the year’s successes and failures. In a few pages, you can really gain insight into the company’s intended direction both strategically and tactically. The CEO usually discusses revenue and revenue goals, expenses and how they are controlling spending, and their priorities are going forward. There may be a great deal of actionable intelligence to be gained from the Letter to the Shareholders.

Next, Iook at the 10-K itself. First, remember every company is different. An entertainment company like Disney is very different from a finance company like Goldman Sachs. With that in mind, you have to look at each 10-K a bit differently. The layout, however, is largely the same from company to company.

Part I of the 10-K lays out the basic business and operations and risk factors they face in the market. Often times the language is boilerplate that are used in every filing. However, I would advise you to not to ignore these sections. Take a moment and skim them; sometimes they discuss a risk that has recently impacted their or their industry’s business or that you could impact (e.g. the security breach at Home Depot).

Item 3 is typically legal proceedings. I like to scan this section to see if there is litigation that my solution could impact. Perhaps an automotive manufacturer is in a class action lawsuit for a particular defect, and my product would have helped them with managing repair history or past claims. This is, of course, actionable intelligence I can use in the sales process.

Part II contains Item 6 with highlights from selected financial data.  Item 7, Management Discussion and Analysis (MD&A), begins with a recap of the previous year’s results. It discusses the financial highlights, including revenue, expenses and capital spending. The MD&A often includes a discussion on business strategy and some forward-looking thoughts. A great deal of actionable intelligence may come out of the MD&A (some say the best way to understand what is happening at a company is to read the MD&A carefully). One suggestion you may consider is using the control-F function (for PC users) to search on keywords. For example, if you sell security software, a keyword like “breach” could render a lot of insight. Using the search feature will save you a lot of unnecessary reading (sometimes these documents are 300 pages long or more).

Also in Part II is Item 8, where the most critical summary annual financial statements may be found. Item 8 contains copies of the full corporate financial statements and supplementary data. The financial statements are great for tracking trends and making a determination as to whether a company is growing, shrinking, spending too much on SG&A, or not investing in their own growth. By reviewing their financials you can determine how much debt they owe, how much cash they have, working capital, and free cash flow. You can also determine of course the company’s net worth. There is a great deal of actionable intelligence in the P&L, balance sheet, and cash flow statements.  TFP, by the way, offers in-depth remote and in-person training on understanding financial statements among other topics.

Following the financials is the notes section. This section may help explain the numbers in the financial statements. I like to skim through the notes and look for anomalies in the data. When I don’t understand what was reported or something just doesn’t seem right, I will always look in the notes for an explanation. It may explain some of the calculations and policies applied for things like share re-purchases and depreciation. Keep in mind a small change in the policies used to depreciate assets can dramatically change the profitability of a company.

A balance sheet from the 10-K

Finally, every quarter, and annually the executives of the company hold an earnings call where they present the financials. It is also an opportunity for analysts to ask questions. My final suggestion to you is sit in on a call or download the transcript. You may be surprised at how much you can learn from these presentations.


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