In the previous post, we have touched upon the current issues with annual reports in Vietnam. The financial review in an annual report, including financial statements and footnotes, is of particular interest to investors. Nonetheless, there are differences between the way this section is approached in Vietnam and in Western countries such as the US and UK due to legal, social, cultural and political dissimilarities.
Limitations of the annual financial review
Regardless of country, there are certain points of caution investors need to remember when analysing the financial review.
1. Inflation could lead to variances financial data recorded in the financial statements, especially when they are only published on an annual basis.
2. Changing market conditions also affect a company’s performance, causing variances in financial ratios.
3. Management can take advantage of complex accounting standards to actively create favourable financial ratios, which renders the whole annual report ineffective as an objective assessment tool. This is noted in the findings of an ACCA study (2012) on annual reports, in which 68% of respondents claimed the document is overly complex due to reporting standards, and the number of people who agreed that standards encouraged transparency was roughly equal to that of opponents.
4. A mixture of very good and very bad ratios can make it difficult to gain an overall perception of a company’s financial situation.
5. For large-scale companies operating in various, if not very distinct sectors, it is hard to build and apply a meaningful industry average ratio system.
6. Currently, there have been no agreed standard calculations of some ratios, which may cause problems when referring to different sources.
Zooming into Vietnam
Due to inherent dissimilarities in socio-political and economic landscapes, even though Vietnam has strived to follow international standards, there are some points investors need to keep in mind:
1. The first challenge when analysing financial statements of companies in Vietnam is a lack of industry average statistics for comparison, which may reduce the significance of assessing a company’s financial performance.
2. The second issue is a lack of separation between operating costs and interest expense in the income statement. Thus, readers rarely analyse using financial leverage ratios, unless they are important to the bank and creditors so preparers have to find a way to separate these expenses from financial activities expenses.
3. The Return on Equity (ROE) ratio attracts much attention from investors and shareholders. However, the financial statements only state the net profits while in reality, not all net profits belong to the shareholders as the company has to establish other funds. Therefore, ROE may cause distorted expectations for shareholders and investors.
4. The credibility of figures on the financial review is not high, even for audited reports. This signals a loophole in the law regarding financial auditing. Meanwhile, for Western readers, the role of external auditors in verifying information from companies is crucial, as confirmed in the aforementioned ACCA report.
5. In Vietnam, analysis of financial reports is rarely done by top management for the purpose of internal assessment; rather, it is by external parties such as banks or stock companies.
In the next post, we will discuss what companies in Vietnam can do to improve their corporate financial reports. In the meantime, to learn about the state of annual reports in Western countries to achieve real-time planning, read the aforementioned report from ACCA “The road to real time reporting” today!