nts smaller than that red by the SEC in its Form .. Forty-one per cent of these panies reported contribuns to sale by segments larger ian 15 per cent.

A similar analysis was made of contributions made by segments to earnings. The contributions to earnings made by "miscellaneous" or "other products" were eliminated, and the size of the smallest segmental contributions to earnings was averaged. The results were as in Exhibit 2.

Thus, only 13 per cent of the companies which reported contributions to earnings reported these for segments smaller than required by the SEC for Form 10-K. Sixty-one per cent of these companies reported contributions to earnings by segments larger than 15 per cent.

LOCATION IN ANNUAL REPORTS

One of the most confusing aspects encountered in making a survey such as this is the task of finding where the breakdowns of sales and earnings may appear in the annual report. There appears to be fairly wide differences of opinion from company to company as to where these figures

EXHIBIT 2

Percentage of Total Earnings Contributed by Segment Under 5%

5-9%

10-14%

15-19%

20-24%

25-29%

Over 30%

should be located. What is perhaps even more disturbing is the feeling the researcher gets that in some companies, at least, the approach has been to try to find the spot in the report where these figures are least likely to be seen.

Forty per cent of the companies which did report these breakdowns in 1970 annual reports placed them in the financial review section (usually towards the back of the report and near the financial statements). Another 20 per cent placed sales and earnings breakdowns in the financial highlights section at the very front of the report.

But another 40 per cent of the companies which reported these figures tended to obscure them by placing them either in the operations review (20 per cent), the president's or chairman's letter (14 per cent), or other places (6 per cent) such as fiveor ten-year financial summary or in the smali-type footnotes to the financial statements. Of the total companies reporting sales or earnings breakdowns, only five companies showed the breakdowns in the financial statements themselves where the segmented contributions would be covered by the auditors' certification.

Percentage of Sample Companies Reporting Earnings Breakdowns

1%

12%

27%

12%

12%

9%

27%

RESERVATIONS AND RECOMMENDATIONS

While the upsurge in improved and expanded segmented reporting in 1970 annual reports is most commendable (and is a marked increase over previous years), corporate managements are still overlooking a number of vital reporting elements which would make these reports far more effective.

For segmented financial information to be of real value to present and potential investors, it would seem that, in addition to the figures themselves, at least the following information should also be included:

1. A complete description of the operating segments which are reported. This would include the general philosophy used to separate the company's activities into segments and the specific parts of the company or product lines which are included in each segment. The segments which are described in the report should correspond to a major degree with the segments for which financial information is reported. In the 1970 annual reports surveyed, only 9 per cent of those companies which reported segmented contributions to sales and earnings also described the segments themselves. One of the most comprehensive descriptions of these segments appeared in the report of Eagle-Picher Industries, Inc. The contributions to sales made by six operating groups were reported, and six pages were devoted to describing the divisions within each group, the products made by each division, the principal markets served by each division, and the location of plants, mills, and distribution centers within each group. In introducing this section of the report, Eagle-Picher succinctly pinpointed what should be included by all companies when reporting segmented data: "The following pages are devoted to EPI's opera

tions and contain information on our products, markets, management and organization-in short, a description of what the company does."

Eaton Yale & Towne, reporting for the first time worldwide sales and pre-tax income contributions, used a considerably more compact but still useful approach. Good segment descriptions also appear in, among others, Ceco Corporation, American Chain & Cable, BucyrusErie, National Lead, and Pillsbury.

Many companies, perhaps too many, described the operating segments of the firm in one fashion and then reported financial data derived from different or overlapping segments. G. D. Searle, for example, reported sales by four lines of business: pharmaceuticals; instrumentation and health testing; laboratory and hospital supply; and others, including animal health and diagnostics. In the body of the report, however, Searle's operations were described under four different classifications: domestic pharmaceutical operations; analytical and clinical instruments; health testing and diagnostic services; and international operations. StudebakerWorthington's approach was even more confusing, with financial data given for 11 divisions and subsidiaries, but with descriptions of 13 (some with different names). Boise-Cascade paid specific attention to this problem and even went so far as to state that the breakdown of income contribution and sales and services by major markets was "consistent with the market descriptions" shown elsewhere.

A similar descriptive weakness occurs when an operating segment is discussed only in terms of important happenings during the year in that segment. It is of relatively little value to an investor to know of a big new contract for a division of the company if he has no clear idea of

what the division or operating segment makes in the first place. Most companies appear to assume that investors already know what makes up each operating segment. So, if any description of the segment appears in the report, it covers new products or market trends and may well ignore the chief products of the operating segment which may be "bread and butter" items.

Then, too, there are still some companies who report financial data by segments but give these segments generic names which are so broad as to be meaningless. Often, the segments are given names such as "consumer products," "industrial products," "non-automotive products," etc., which may mean something to the company's management but which provide very little information of use or interest to investors.

Another weakness often found in segment descriptions is in their placement in the report. In many cases, these descriptions are shown piecemeal throughout the report and are not coordinated with the presentation of figures on these segments. Ideally, the description of the segment which is being reported on and the figures showing this segment's contribution to sales and earnings should be near each other in the report. The placement of these descriptions in the Burroughs report shows how effective the presentation can be when figures and descriptions are coordinated in one location.

2. A second major drawback in the 1970 presentation of segmented data is the lack of description of the figures themselves. To be complete, these presentations should clearly show the accounting methods used to arrive at the segmented financial data, including the treatment, inclusion or exclusion of such revenue and cost items as intercompany transactions, common or joint costs, corporate expenses, interest, in

come taxes, extraordinary items, etc. Of the companies in this survey sample who reported segmented financial information, only 20 per cent made some attempt to explain the real meaning of these figures.

General Electric, in reporting sales and net earnings by six major categories, provided a complete and concise account of how these items were handled: "Sales and earnings for each major category include intercategory transactions. To the extent that sales and earnings are recognized in more than one category, appropriate elimination is made at the corporate level. Net earnings for each major category are after the allocation of corporate items such as expenses of headquarters personnel, the Research and Development Center, interest and other financial charges and income taxes."

Alco Standard showed the results of its eight major companies in a single table, with a brief description of how these figures were derived.

A somewhat less important but equally irritating weakness in some presentations of segment contributions is the failure to state these contributions in terms of percentages of the whole. National Distillers and Chemical, for example, in what is otherwise an excellent presentation of divisional sales, operating profit, and return on investment, states these items in terms of dollars and does not precalculate these figures in terms of percentages of total sales and profits. Admittedly, it would not be particularly difficult for the investor to make these calculations himself, but when so much time and effort has been expended to make a report meaningful, why not include this one more small item and prevent possible arithmetic mistakes by an investor or an analyst?

An outstanding example of how this can be shown appears

92-578 O 73 51 (2B)

in the report of Gulf & Western Industries, where net sales and operating income of 12 operating groups are shown in dollars and percentages. Later in the report, these 12 groups are broken down into 36 product lines. Sales of each of these lines is presented in dollars and also in percentages of total group sales and of total corporate sales.

3. A third basic weakness in some presentations of segmented data on sales and earnings is the failure to reconcile the sum total of the contribution of the segments to those shown on the company's consolidated financial statements. While it is true that an investor with a reasonably sophisticated knowledge of accounting could probably make this reconciliation for himself, not all investors have this ability. Even though few of the reports studied for this survey failed to make this reconciliation, when it was made, it was sometimes difficult to interpret.

4. Finally, as mentioned earlier in this article, one of the most apparent weaknesses in disclosure of segmented information is in the style and tone of the presentation. Weyerhauser, for example, included a full page, seven-color, subdivided surface chart to show the growth in net sales of seven divisions and the corporation as a whole. Impressive as this may be on first glance, one quickly discovers that in order to obtain reasonably accurate estimates of each segment's contribution, would need a draftsman's callpers to measure the width of each band, since each must be read from the band below. No explanatory figures were given separately. Farmland Industries used a similar approach.

one

Many companies fail to give comparable breakdowns for previous years when they introduce segmented reporting for the first time. While it may be difficult to develop these figures for prior years, it should be remembered that the presentation of only one year's segmented contributions gives little idea of the dynamic perspective of corporate growth. Likewise, many companies

22 FINANCIAL EXECUTIVE August 1971

still appear to search for the smallest type size available to use in presenting segmented information. Or, even if a readable type size is selected, the figures are printed in an ink which does

not contrast properly with the paper color. How can an investor be expected to read pink figures printed on orange paper? Or light tan figures printed on dark brown paper?

Some personal observations

Over the course of the past five years, I have studied some 4,000 to 5,000 corporate annual reports in detail, and perhaps I may be allowed to conclude this fifth survey with some personal comments on the general state of the art of reporting to shareowners.

In general, the art has degenerated into a lifeless and imitative copying of (1) what was done last year; (2) what the competition is doing; and (3) what new things are being required, whether by the SEC or by the Accounting Principles Board. What is specifically missing from the art today is any feeling that reporting to shareowners is something other than a routine and distasteful duty that has to be done each year.

One is overwhelmed by a meaningless clutter of unrelated and irrelevant trivia which has little bearing on the basic purpose of an annual report-to give present and potential investors the information they need in order to make investment decisions. Although reporting requirements today are such that much of this information must be included, one has to wade through a welter of public relations nonsense in order to extract essential information bit by bit. To be sure, there are endless photos of highly technical new products and processes; there are numerous photos of new warehouse and distribution facilities (which from the photos appear to be completely interchangeable among companies); this year there are token photos of black employees judiciously placed for maximum attention; and, 1970's leading item-the obligatory and empty discussion of ecological and environmental

problems.

Management seems to have forgotten that its first obligation to investors is to tell them what the company is, what it is trying to do, what it has accomplished, and where it has failed. This is the excitement of business, and this is what is missing from most annual reports. Too often the tone of the report is static, defensive, and self-inflating rather than dynamic.

One wonders if perhaps the main reason for the sagging quality of annual reports is the lack of involvement of the financial executive in the entire annual report. In many companies today, his involvement stops with the financial sections and with a cursory review of the president's letter. If the purpose of the report to shareowners is to translate the company's activities for the past year into financial terms, shouldn't the financial management of the company assume the responsibility for designing, writing, and producing the report, rather than leaving it to the public relations and advertising departments, the secretary's office, or some miscellaneous corporate group? Isn't the financial executive in the best position to analyze the company in the manner which would allow it to put its best foot forward for present and potential investors? Isn't the real purpose of the report to present this financial information to investors? Shouldn't the heart of the report the financial sections-govern the design and production of the rest of the report, rather than vice versa? Isn't it time the financial executive again assumed the full responsibility for what is essentially his job? GH