*Explaining On The Various Processes Of Auditing And Company Reporting And Showing The Preliminary Announcement*. This material contains information about the various roles of the auditors, company reporting and preliminary announcement plus showing the accounts of profit and loss.

With the accounts will come an auditors’ report. Auditors are firms of accountants who hold a watching brief on behalf of the owners of the company (the shareholders). The directors of the company prepare and sign the accounts. It is the auditors’ job to certify that these accounts present a true and fair view of the company’s profits and financial position, or to point out any failings where they do not.

The auditors are meant to be independent of the company’s management, though obviously need to work quite closely with the managers in agreeing the form of the accounts. The managers appoint them, though the shareholders approve their fees. There is normally a certain amount of give and take when opinions vary on the presentation of different items. An auditors’ report which says the accounts do not give a ‘true and fair view’ or that they do so only with important qualifications will normally be picked up by the press as a strong warning bell.

Companies which are quoted on the Stock Exchange need, we have seen, to provide their shareholders with more frequent information than that supplied by the legally required annual accounts. Some weeks after the end of the first half of the company’s year it will normally produce an interim profit statement (or interim) giving unaudited first half profit figures. The statement also normally gives the size of the interim dividend and includes some comment on trading and prospects from the company. Some time after the end of the full year a preliminary announcement (prelim) will usually be published, giving the profits for the year and often a lot of background information. This appears some weeks before the full report and accounts are posted to shareholders. Most daily press comment on the company’s figures is based on the interim and preliminary statements which have greater news value though less depth of information than the full accounts. A profit and loss account shows the results of a company’s trading over the last financial period. Usually this means a year, though the year can run to whatever date the company chooses. December 31 and March 31 year ends are popular, though it could be April 1 or November 5. The profit and loss account thus shows the effect on the company’s revenue account of all the transactions over the past year. If a company made profits of £20m in the first ten months of its year and losses of £22m in the last two months, the profit and loss account would show a loss of £2m: the final outcome. It would not by itself reveal that the company had been trading profitably for much of the period.

First, what is a company? It is a trading entity that belongs to its shareholders and the Ltd or plc after the name indicates that it has limited liability. The plc also indicates that the company is a Public Limited Company: one whose shares or other securities may be held by the investing public and traded on a market. In either case the liability of the owners is limited to the amount of money they have put into the business.

Unless they give personal guarantees for the debts of the business, the owners or shareholders (members, in the legal jargon) of a limited company cannot be called on to meet the company’s debts where these exceed its assets. Only the money put into the company can be lost. Anybody who operates a business as a sole trader or as a partner in a partnership, on the other hand, is liable for all the debts of the business.

The owners of the ordinary shares in a company normally have the power to control the company if they act together, though the directors and managers who may or may not be shareholders run the company. Usually each ordinary share carries one vote. Owners of more than 50 per cent of the votes will thus if they all vote the same way they control the company.

In practice shareholders can influence the way a company is run primarily by voting on the appointment or dismissal of directors and on certain other major policy matters that have to be presented to shareholders at a formal meeting of the company. Certain major resolutions to change the aims and objectives of a company, say will require 75 per cent voting in favor.

Most of the time shareholders vote the way the directors advise them to, especially at the annual general meeting or AGM of the company, which is normally a non contentious event where the required resolutions are duly passed. The press will generally pick up the occasions when there is dissent between different groups of shareholders or between shareholders and directors. This is where the question of voting power becomes interesting.

Ordinary shareholders are entitled to receive accounts. As a rough rule (it’s not technically quite correct) companies are required to produce a set of accounts each year. This is a legal requirement. The Stock Exchange further requires that listed companies produce figures showing profits at the half year stage (in America they produce them each quarter).

The best way to look on accounts is as a sort of shorthand for what is really going on in a company. The bare figures don’t conjure up the smoking chimneys or the salesmen out on the road. But once you are reasonably familiar with the basic figure work you can begin to look at what lies behind it.

The main items in the accounts are a profit and loss account, a cash flow statement and a balance sheet. Under recent accounting rules, the company should also include a statement of total recognized gains and losses and a note of historical cost profits and losses but we do not need to bother too much with these for the moment.

Various other bits of information required by law, by the accounting standards of the day or by the Stock Exchange in the case of a listed company are usually contained in the directors’  report or in the detailed notes to the accounts. In practice, the report and accounts of Stock Exchange traded companies normally contain a lot more information in the form of a chairman’s statement, a review of the year’s trading and statements of compliance with various codes and practices that companies are meant to observe. Lavish colour illustrations may also bulk out the document.

Financial journalists write extensively about companies. Companies that are growing, companies that are contracting, companies that are taking over other companies, companies that are going bust. They tend to approach company affairs from one of two angles (or, most usefully, from both). Take two examples:

‘Mark Hustler, the thirty year old accountant who took charge at Interpersonal Video Systems earlier this year, has not let the grass grow under his feet. Following the purchase of Insight Compact Discs in June he plans a further important acquisition in the interpersonal systems field to consolidate the company’s lead in this fast growing business. The shares are acquiring a strong institutional following and at l8Op up from 6Op earlier this year look one of the best bets in the high technology sector.’

What do we deduce from this? First, that the writer thinks Interpersonal Video Systems is a good thing, because he is advising you to buy the shares. Secondly, that he is suggesting the investing institutions are buying the shares, which should help the price to rise. Thirdly, that the shares have already risen strongly, presumably since Mark Hustler took charge. Fourthly, that Mark Hustler is expanding his company by buying other companies. Fifthly, that the company is a leader in interpersonal systems and that these are a high technology area.

Finally, we might suspect that the writer probably hasn’t the faintest idea what an interpersonal video system is, whether it is a growth business, whether Mark Hustler is paying too much or too little for the companies he is acquiring or who the institutions are that are supposed to be following the company. In other words, the writer has clearly had a tip. It’s not necessarily to be sneezed at. If enough people follow the tip and buy the shares because they think they are going up, they will go up. For a time at least.

‘Interpersonal Video Systems, the manufacturer of visual sales aids for the toothpaste industry, reports turnover up from £18m to £27m for the year to end March. Pre tax profits have risen from £2m to £4.3m, including a first time contribution of £1.5m from Insight Compact Discs, acquired for shares last June, and earnings per share are up from lOp to l2.5p on the enlarged capital. If the company meets its target of 15 per cent a year internal growth, the 25p shares at l8Op are on a prospective PE ratio of only 12.5, which is below the sector average. They look undervalued.

In fact, the message from the second writer is essentially the same as that from the first: the shares should be bought. Not because Mark Hustler is a great guy, not because another important acquisition is planned, not because institutions are rushing to buy the shares. But because the conventional investment arithmetic says that they are cheap. We also learn roughly what Interpersonal Video Systems does and we have an indication that it probably didn’t pay too much for Insight Compact Discs.

Neither approach is totally satisfactory on its own. It is useful to know who runs a company. It helps us to get a feel for the operation if we know it plans expansion via take over. It is useful to know (if, in fact, it is true) that institutions are investing in the company. But it is also useful to know what it does, how much it earns and how it is rated on accepted investment criteria.

Phrases like ‘PE ratio’ and ‘earnings per share’ are part of the currency of the investment business. But what do they mean? This requires a gentle incursion into company accounts.