Notes to Financial Statements

Notes to financial statements, often called footnotes, are the explanatory information that accompanies a company's financial statements. They are an integral part of those statements under both US GAAP and IFRS, and auditors' opinions cover them as well as the balance sheet, income statement, statement of comprehensive income, statement of changes in equity and statement of cash flows. The notes describe the accounting methods the company has used, explain the main judgments and estimates, break down summarized figures and disclose information that does not appear in the primary statements at all. The shorter name footnotes remains common among analysts and auditors.

The notes are where much of the most useful information for investors and lenders is found. A single balance sheet line such as "long-term debt" may be supported by several pages of notes describing each borrowing, its interest rate, maturity and covenants. In a typical annual report on Form 10-K, the notes are far longer than the statements themselves.

• Basis of presentation and significant accounting policies, such as revenue recognition, inventory methods, depreciation methods and consolidation principles.
• Critical judgments and estimates, including assumptions behind goodwill impairment tests, pension obligations, credit loss allowances and fair value measurements.
• Breakdowns of balance sheet items: inventory by category, property and equipment by class, intangible assets, receivables and payables.
• Debt and leases: terms, interest rates, maturity schedules for the next five years, covenants and collateral.
• Income taxes: reconciliation of the statutory and effective rates, and the components of deferred tax assets and liabilities.
• Commitments and contingencies, such as purchase obligations, guarantees and lawsuits, including any contingent liability that is not recorded.
• Equity and share-based compensation, earnings per share, segment information, related party transactions and events after the reporting date.

A manufacturer's balance sheet shows long-term debt of $480,000,000. The debt note reveals that $300,000,000 is a term loan maturing in two years, carrying a floating rate of SOFR plus 2.25 percent, and that the loan requires net debt to be no more than three times EBITDA. With EBITDA of $190,000,000 and cash of $40,000,000, net debt to EBITDA is:

Here $\text{Total debt}$ is all interest-bearing borrowing, $\text{Cash}$ is cash and equivalents, and $\text{EBITDA}$ is earnings before interest, taxes, depreciation and amortization. The result is $440,000,000 divided by $190,000,000, or about 2.3 times. The primary statements alone would show neither the covenant nor the refinancing risk of the large maturity in two years; the notes allow a lender to see that a fall in EBITDA of roughly 23 percent would breach the covenant.

Disclosure requirements are spread through the individual standards: each topic in the FASB Accounting Standards Codification and each IFRS standard sets out what must be disclosed about that area. The full disclosure principle requires that all information material to users be provided. Public companies in the United States must also follow SEC Regulation S-X, and they present management's discussion and analysis outside the audited statements. Recent standards have added disclosures, such as expanded segment expense reporting under ASU 2023-07 and more detailed income tax disclosures under ASU 2023-09. Both standard-setters have also encouraged companies to remove immaterial disclosures, so that important information is not buried.

Experienced analysts often read the notes before the statements. Useful checks include comparing accounting policies with peers, looking for changes in estimates such as useful lives or bad debt rates, examining the maturity profile of debt, reviewing contingent losses from litigation, and reading the subsequent events note for developments after year end. Changes in policies or unusually long explanations of a single area can signal judgment calls worth questioning. The notes also explain non-GAAP reconciliations, segment results and transactions with related parties. Since the information is tagged in machine-readable form for SEC filers, the notes can be searched and compared across companies, and investors reading audited financial statements can also review the auditor's report, which highlights critical audit matters linked to specific notes.