The Accounting Act requires all legal persons (general partnership, limited partnership, limited liability company, cooperative, foundation or association) to provide financial statements. Companies also need financial statements when preparing tax returns, as attachments for tax returns, because of commercial contracts and, for example, when applying for funding.
Financial statements
Companies present their results on financial statements at the end of each accounting period. Financial statements must be drawn up four months after each accounting period. A date and signature are added when the statements are ready.
The financial statements of micro enterprises and SMEs include an income statement, balance sheet and appendices. Larger companies must add attachments such as cash flow statements and a report by the Board of Directors, and provide comparative figures from the previous accounting period.
Income statement
An income statement shows the structure of a company’s income during an accounting period: it presents the company’s income and expenses. This provides a basis for assessing the profitability of business activities. Expenses and taxes are subtracted from income (net sales) for the period. The bottom line then shows the profit or loss for the accounting period.
How to read an income statement
You should note that the figures in an income statement are exclusive of VAT. Begin by looking at whether the company made a profit or loss during the accounting period. Find ‘operating profit’ and total profit or loss. Operating profit is profit or loss on the company’s core activities. Profit or loss for the accounting period shows the bottom line after expenses and taxes. Next, it’s worth looking at how net sales performed, or how operating expenses developed.
You should also compare the income statement figures with those of competing companies and with your company’s figures for the previous accounting period. Take time to consider how past decisions and actions have impacted on the income statement. A business needs to be profitable in the long run, to provide it with sufficient liquidity and solvency to grow, for example.
Balance sheet
A balance sheet describes a company’s situation on the balance sheet date. It presents the company’s assets and liabilities. A balance sheet’s structure and content are determined by the Accounting Act and regulations, to ensure that it accurately depicts the company’s financial situation.
A balance sheet has two sides: assets and liabilities. One side presents the company’s assets – what the company owns and the assets it has available for paying its debts. Liabilities are what the company owes or might owe, in other words equity and financial capital, so liabilities refer to what the company owes to other parties. Equity is a company’s assets minus its liabilities. Both sides of the balance sheet must be equal. If this is not the case, there has been an accounting error.
How to read a balance sheet
A balance sheet records a company’s financial situation on the balance sheet date. It can be used to assess a company’s solvency – its ability to pay its debts. Being highly solvent helps a company to come through difficult times. For example, if a loss is recorded in ‘Equity’ and the company still has plenty of equity, this is due to earnings from previous accounting periods, or perhaps equity investments. So equity still remains strong, even though it shrinks by the loss amount recorded.
You can also use a balance sheet to estimate your company’s liquidity on the balance sheet date, by subtracting current liabilities from current assets. The result is positive if the company can meet its financial obligations in the short term.
Ask your accountant to help you interpret anything that seems unclear on the income statement or balance sheet. This will enable you to make decisions and plan ahead for your company.