How to Read a 10-K: A Walkthrough of Microsoft's 2026 Annual Report

Check the claimThree habits this walkthrough asks you to drop

ClaimRead a 10-K front to back, starting with the business description.Tap to checkMythStart with the MD&A summary and the statements. The description is mostly marketing; read it last, with questions.Flip backClaimIf net income rose 31%, there's more cash for shareholders.Tap to checkMythMicrosoft's net income rose 31% while its free cash flow fell 6%. The 10-K only supports the first claim.Flip backClaimThe quarterly 10-Q is audited, just like the 10-K.Tap to checkMythA 10-Q is reviewed but not audited, and its statements are condensed with fewer notes.Flip back

A 10-K follows a fixed layout set by SEC rules, so once you know one, you can find your way around any of them:

The order to read it in

A 90-minute first pass, with the notes taking longest

1. 1. MD&A overview and highlights (Item 7)Management's own one-page summary of the year10 min11.1% of total
2. 2. Income statement, balance sheet, cash flow statement (Item 8)The audited numbers the summary should match20 min22.2% of total
3. 3. Segment results (MD&A and the segment note)Shows which part of the business drove the year10 min11.1% of total
4. 4. Notes on revenue, leases, investments and taxesWhere obligations and one-off items are disclosed25 min27.8% of total
5. 5. Risk factor headings (Item 1A)Skim the headings and read only the new ones10 min11.1% of total
6. 6. Auditor's report, critical audit mattersWhere the auditor says the hardest judgments are5 min5.6% of total
7. 7. Business (Item 1)Context, once you know which questions to ask10 min11.1% of total

Reading the numbers before the business description sounds backwards. But the description is mostly marketing, and reading it first makes you trust the story before you've checked it. Read it last, with questions.

Step 1: what management says happened

Item 7 opens with highlights. For fiscal 2026 Microsoft reported:

• Revenue up 18% to $331.8 billion, driven by Microsoft Cloud, which rose 27% to $214.4 billion
• Azure and other cloud services revenue up 41%
• Operating income up 21% to $155.2 billion
• Microsoft Cloud gross margin down to 66%, "driven by continued investments in AI infrastructure and growing AI product usage"

Spot the red flag

Revenue rose 18%. One of management's highlights warns that the growth got more expensive. Which?

Microsoft fiscal 2026 highlights, Item 7

Revenue up 18% to $331.8 billion. Microsoft Cloud up 27% to $214.4 billion. Azure and other cloud services revenue up 41%. Operating income up 21% to $155.2 billion. Microsoft Cloud gross margin down to 66%.

Tap the phrase you think is the tell.

Spotted it.Not that phrase. A falling cloud gross margin while cloud revenue grows is the question to carry into the statements: is the AI build-out costing more than it's bringing in?

• “Revenue up 18% to $331.8 billion” Growth, but it says nothing about what each dollar cost to deliver.
• “Microsoft Cloud up 27% to $214.4 billion” The engine of growth, not the warning.
• “Azure and other cloud services revenue up 41%” The fastest-growing line; the cost shows up elsewhere.
• “Operating income up 21% to $155.2 billion” Still rising faster than revenue overall.
• “Microsoft Cloud gross margin down to 66%” Each dollar of cloud revenue cost more to deliver, "driven by continued investments in AI infrastructure."

Explain every phraseHide the other explanations

Note the last point. Revenue rose, but each dollar of cloud revenue cost more to deliver. That gives you your first question to carry into the statements: is the AI build-out costing more than it's bringing in?

Step 2: the three statements

Here are the headline lines, taken straight from Item 8:

Net income grew 10 points faster than operating income. The gap is "other income," which went from a $4.9 billion loss to a $10.7 billion gain. When profit below the operating line moves that much, find out why before you quote the growth rate.

The MD&A answers it. Net income included a $5.0 billion after-tax gain from Microsoft's investment in OpenAI, mostly a "dilution gain from the OpenAI Recapitalization," against a $3.6 billion loss the year before. Strip both out and net income grew about 22%, not 31%:

Microsoft reports this adjustment itself, as non-GAAP "adjusted net income." GAAP means generally accepted accounting principles, the official rules; non-GAAP figures are the company's own adjusted versions. Here the adjustment is reasonable, because an accounting gain on an investee's recapitalization isn't operating profit. Even so, always check what a non-GAAP figure removes and whether it removes losses as readily as gains.

Without OpenAI, net income grew in line with operating income

Net income, as reported+31%

Net income excluding OpenAI+22%

Operating income+21%

Revenue+18%

Worked check: reconcile profit to cash

The cash flow statement starts with net income and adjusts it to cash. Lining up those adjustments is the fastest test of earnings quality, meaning how closely reported profit matches cash coming in.

Depreciation does most of the work from profit to cash

Net income$133,749

Depreciation, amortization, and other+$38,534= $172,283

Stock-based compen­sation+$12,405= $184,688

Net gains on investments and derivatives−$11,047= $173,641

Deferred income taxes+$14,189= $187,830

Changes in working capital (nine lines)−$4,895= $182,935

Net cash from operations$182,935

The rows add up exactly. Three of them are worth a closer look:

• Depreciation of $38.5 billion, up 31% in a year. Servers bought in the AI build-out are now being expensed. Our research on the AI depreciation lag explains why that charge keeps rising after spending peaks.
• Stock-based compensation of $12.4 billion, about 9% of net income. It costs no cash, but shareholders pay for it through dilution.
• $11.0 billion of investment gains subtracted. These are mostly the OpenAI gains, which boosted net income but brought in no cash, so the statement takes them back out.

Cash from operations covered net income 1.37 times, which is healthy. The trouble comes on the next line.

Make a guess

Capex rose 80% in fiscal 2026. How many cents of every dollar of operating cash did it absorb?

Tap your guess

0¢Your guess: 0¢10¢Your guess: 10¢20¢Your guess: 20¢30¢Your guess: 30¢40¢Your guess: 40¢50¢Your guess: 50¢60¢Your guess: 60¢70¢Your guess: 70¢80¢Your guess: 80¢90¢Your guess: 90¢100¢Your guess: 100¢

01234567890123456789¢Capex ÷ operating cash

Spot on.Close, a little low.Close, a little high.Way off, too low.Way off, too high. It was 63¢.

$115.9B of capex against $182.9B of operating cash: about 63 cents of every dollar, leaving free cash flow of $67.0B, down 6%.

Capex ÷ operating cash63¢

Fiscal 202547¢

Free cash flow: where the 31% disappears

Free cash flow is cash from operations minus capital expenditure (capex), the money spent on property and equipment. Microsoft doesn't report it in the 10-K, so you work it out yourself:

Capex rose 80% and took 63 cents of every dollar of operating cash. Even that understates the spend:

• Finance leases. Microsoft obtained $24.6 billion of equipment and datacenters through finance leases in fiscal 2026, according to Note 13. Leased assets never show up as capex. Count them and free cash flow drops to roughly $42 billion.
• Component prepayments. The MD&A says investing cash also rose because of a "$22.2 billion increase in cash used in other investing primarily to facilitate the purchase of components." That sits in "Other, net," not the capex line.

Count finance leases and free cash flow falls to about $42 billion

Net cash from operations$182.9B

Additions to property and equipment−$115.9B= $67.0B

Finance-lease assets (Note 13)−$24.6B= $42.4B

Lease-adjusted free cash flow$42.4B

None of this means Microsoft is in trouble. It means "net income up 31%" and "more cash for shareholders" are different claims, and the 10-K only supports the first one. To test how long spending at this level can be funded, put these figures into the capex and free cash flow coverage calculator.

Step 3 and 4: what the notes add

The notes come after the statements and take the longest. For Microsoft, four of them change the picture.

Spot the red flag

This sentence from Note 13 describes $329.1 billion of leases. One phrase tells you they aren't on the balance sheet yet. Tap it.

Microsoft 10-K, Note 13: Leases

As of June 30, 2026, we had additional leases, primarily for datacenters, that had not yet commenced of $329.1 billion.

Tap the phrase you think is the tell.

Spotted it.Not that phrase. Search any 10-K for "not yet commenced": it's where signed obligations wait before they reach the balance sheet.

• “As of June 30, 2026” The date of the disclosure, not its status.
• “we had additional leases” "Additional" matters, but on its own it doesn't say why they're missing from the balance sheet.
• “primarily for datacenters” What they're for, not where they sit.
• “that had not yet commenced” A lease goes on the balance sheet when it commences. These start between fiscal 2027 and 2033.
• “of $329.1 billion” The size, nearly four times the $88.5 billion of lease liabilities already recorded.

Explain every phraseHide the other explanations

Note 13, Leases: $329.1 billion not yet on the balance sheet. "As of June 30, 2026, we had additional leases, primarily for datacenters, that had not yet commenced of $329.1 billion." They start between fiscal 2027 and 2033. Compare the leases already on the balance sheet, $88.5 billion of liabilities, and long-term debt principal of $46.1 billion. The MD&A's contractual obligations table puts total commitments at $743.8 billion, including $194.1 billion of purchase commitments that are "primarily" for datacenters.

Leases not yet started are seven times Microsoft's debt

Leases not yet commenced$329.1B

Purchase commitments$194.1B

Lease liabilities on the balance sheet$88.5B

Long-term debt principal$46.1B

Note 12, Unearned Revenue: a $684 billion backlog. Remaining performance obligations are revenue Microsoft has contracted for but not yet earned. They reached $684 billion, and Microsoft expects to recognize about 30% in the next 12 months. A backlog this size supports the spending, but it's only as good as the customers behind it.

Note 1, Accounting Policies: OpenAI is a related party. Microsoft owns about 25% of OpenAI on an as-converted basis. It recorded $24.1 billion of revenue from OpenAI in fiscal 2026 and was owed $6.0 billion at year end. So OpenAI is both a large customer and an investment whose value flows through Microsoft's income statement.

Note 18, Segment Information. The segment tables show where growth came from and what it cost:

In Intelligent Cloud, the cost of delivering revenue grew faster than revenue itself. That's the margin pressure from Step 1, now pinned to one segment.

Only in Intelligent Cloud did costs outgrow revenue

Revenue growthCost of revenue growth

−101020304050%0

+16%+12%

Productivity and Business ProcessesRevenue growth+16%Cost of revenue growth+12%

+30%+44%

Intelligent CloudRevenue growth+30%Cost of revenue growth+44%

−1%−7%

More Personal ComputingRevenue growth−1%Cost of revenue growth−7%

Productivity and Business ProcessesIntelligent CloudMore Personal Computing

Step 5 and 6: risks and the auditor

Risk factors. Item 1A runs about 17 pages under five headings: strategic and competitive, cybersecurity and privacy, operational, legal and regulatory, and general. Don't read every word. Compare this year's headings with last year's and read what's new or longer. This year, two stand out:

• Power. "The availability, reliability, and cost of electrical power are critical to the operation and expansion of our datacenters."
• Taxes. The IRS is seeking "an additional tax payment of $28.9 billion plus penalties and interest" over how Microsoft priced transactions between its own subsidiaries in 2004 to 2013. Microsoft disagrees and says its reserves are adequate.

Critical audit matters. In its report, the auditor, Deloitte & Touche, names the areas that needed the most judgment. For Microsoft there are two: revenue recognition on multi-product customer contracts, and the uncertain tax positions tied to the IRS dispute. If you only have time for two notes, the auditor has just told you which two.

Red flags we checked

A flag isn't a verdict. It's a question you need to answer before you trust the headline numbers.

10-K vs. 10-Q: what changes

A 10-Q is the quarterly report, filed for each of the first three quarters. Microsoft's fourth quarter is covered by the 10-K.

Read the 10-K once a year to understand the company. Then use each 10-Q to check the same few numbers: capex, free cash flow, the backlog and margins. Microsoft's next 10-Q, for the quarter ending September 30, 2026, should arrive in late October. Material events between reports appear in 8-Ks.

One 10-K sets the baseline; the next 10-Q checks it

1. Jun 30, 2026Fiscal year ends
2. Jul 2910-K filed29 days later; large companies get 60
3. Sep 30First quarter ends
4. Late Oct10-Q expectedDue within 40 days of quarter end

Our read

The 10-K didn't change our view that Microsoft is an exceptional business. It did change which number to watch. Headline earnings growth of 31% was flattered by an OpenAI accounting gain and doesn't reflect cash available to shareholders, which fell. What matters next is whether $684 billion of contracted revenue turns into enough cash to cover $116 billion a year of capex plus $329 billion of leases still to come.

That's what a 10-K is for. It doesn't hand you a conclusion, but it tells you exactly which question will decide one.

Try it yourself

Pick any company you own or are considering. It takes about 30 minutes.

1. Open its latest 10-K on EDGAR and find Item 7. Write down revenue, operating income and net income growth.
2. If net income grew faster than operating income, find out why in "other income" or the tax line.
3. Go to the cash flow statement. Divide cash from operations by net income, then subtract additions to property and equipment to get free cash flow.
4. Search the document for "not yet commenced" and "purchase commitments" and note the totals.
5. Read the critical audit matters in the auditor's report.
6. Compare your numbers with the company's stock page. Anything you can't explain is your research question.

Questions readers ask

How long does it take to read a 10-K?

A focused first pass takes about 90 minutes for a large company, using the order above. Reading every word of Microsoft's would take most of a day, and most of it wouldn't change your view.

What is the most important part of a 10-K?

The financial statements and their notes in Item 8. MD&A tells you what management wants you to notice. The notes tell you what it is required to disclose, including leases, commitments, related parties and one-off gains.

What's the difference between a 10-K and an annual report?

The 10-K is the formal SEC filing. Many companies also publish a glossier "annual report to shareholders" with a letter from the CEO. The figures should match, but only the 10-K has the full notes and risk factors in a standard format.

Should I read the 10-K or the 10-Q first?

The 10-K. It sets out the business, the full risks and audited numbers. A 10-Q then shows what has changed since. Our stock research checklist shows where both fit in a full review.

Where can I find older 10-Ks?

On EDGAR, under the company's filings, filtered to form 10-K. Comparing two or three years shows trends that one report can't. Our guide to stock research websites covers free tools that make this faster.

Go deeper with member research

Microsoft's 10-K raises the same question as every hyperscaler's right now: will AI spending earn its return?

• Issue 03: The AI bill is arriving late to earnings: why the depreciation in Microsoft's cash flow statement keeps rising after capex peaks, and when it hits margins.
• AI capex accounting: Microsoft, Amazon, Google and Meta compared: how finance leases and other lines make Big Tech's capex numbers hard to compare, and how to line them up.
• The fundamental research course: 40 chapters covering everything in this walkthrough in more depth, including finding the evidence in US filings, reading the cash flow statement and leases and hidden obligations. The first chapter is free.

Limits of this walkthrough

• Figures come from Microsoft's Form 10-K for the fiscal year ended June 30, 2026, filed July 29, 2026. Later filings may revise or update them.
• Free cash flow and the lease-adjusted version are our calculations, not figures Microsoft reports. Other analysts define free cash flow differently.
• Page numbers refer to the filing's own pagination and are approximate.
• Section order and content vary somewhat by company, especially for banks, insurers and REITs.