What are the financial statements?
Financial statements, completed after the financial year, consist of a financial calculation and the necessary documents that complement it. The Accounting Act requires all legal persons (general partnership, limited partnership, limited liability company, cooperative, foundation or association) to provide financial statements. Preparing financial statements is important even if not required by law. Companies need financial statements when preparing tax returns, as attachments for tax returns, because of commercial contracts and, for example, when applying for funding.
Company's financial statements
Companies present their results on financial statements at the end of each financial year. A company's financial statements consist of the income statement, balance sheet and the necessary notes. Financial statement notes include a cash flow statement, Report by the Board of Directors, list of vouchers and other accounting material, auditor's note and comparison figures from the previous financial year.
A company's financial statements must be completed within four months after the end of the financial year. The annual general meeting of a limited liability company must adopt the company's financial statements within six months after the end of the financial year. A limited liability company must submit the financial statements to the Trade Register within two months after they were adopted. Financial statements and companies' financial details in the Trade Register are public information. Public financial statements are available in the Finnish Patent and Registration Office's Virre Information Service and can be ordered from various service providers.
Drawing up financial statements is optional but sensible for a private trader. Drawing up financial statements becomes mandatory for a private trader if two of the following limits are exceeded during two consecutive financial years.
- The company employed ten people on average during the financial year
- The balance sheet total is €450,000
- The turnover is €900,000
A private trader needs financial statements when applying for a home loan, for example.
What is an income statement?
A company's income statement shows the structure of a company's income during an accounting period. It presents the company's income and expenses. The income statement presents the turnover, operating profit, financial expenses and financial income, appropriations, income tax and depreciation and amortisation.
Turnover
Turnover means the income from services and products sold by the company, before tax and deductions. This provides a basis for assessing the profitability of business activities. Expenses and taxes are subtracted from income (turnover) for the period. The bottom line then shows the profit or loss for the accounting period.
Expenses that can be deducted also include other operating expenses. Other operating expenses include expenses for operating premises, vehicles, devices and software, travel, entertainment and research and development.
Operating profit
Operating profit indicates how profitable a company is. Operating profit is a company's business performance before interest, tax, appropriations and profit distribution. Operating profit can be calculated by subtracting from the turnover the variable and fixed costs and depreciation and amortisation.
The Accounting Ordinance contains two formulas to drawing up an income statement: operation-specific and expense-type-specific. The formulas are different but result in the same operating profit.
Financial expenses and financial income
After the operating profit, the income statement lists the financial income and financial expenses. The result is the company's profit or loss before appropriations and taxes. Financial expenses include interest expenses, impairments on both non-current and current assets, and other financial expenses. Non-current assets are those that may generate income continuously over a few financial years. Current assets are expected to generate a profit only during one financial year.
Appropriations
Appropriations consist of a change in depreciation difference and taxation-based provisions, and Group contribution.
Income tax
Income tax is tax levied on income. Your company's income taxation depends on the company form. If you company is a limited liability company or cooperative, income tax is paid in your company's taxation. A 20 per cent income tax is levied on the earnings of a limited liability company or cooperative. As to other company forms, income tax is levied as part of your personal taxation. You calculate your company's earnings by subtracting deductible expenses and earlier years' losses from the taxable income.
Depreciation and amortization
A limited liability company can deduct the purchase price of fixed assets (such as equipment, machinery, software and buildings) all in one go or as depreciation over a few years if the company's fixed assets are available to the company. Depreciation and amortisation are not actual expenses, but an accounting item. Depreciation and amortisation reduce the financial year's earnings and the amount of tax payable on the earnings.
Other operating expenses
An income statement also contains an item called Other operating expenses. Other operating expenses include expenses for operating premises, vehicles, devices and software, travel, entertainment and research and development.
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.
What is a balance sheet?
A balance sheet describes a company's situation on the balance sheet date. The balance sheet lists the company's assets and liabilities. A company's balance sheet's structure and content are determined by the Accounting Act and regulations, to ensure that it depicts the company's financial situation accurately. A balance sheet has two sides: assets and liabilities.
The assets side of the balance sheet
One side presents the company's assets – what the company owns and the assets it has available for paying its debts. The balance sheet's assets side is divided into two parts, non-current and current assets. Non-current assets generate income to the company over several financial years. Non-current assets include:
- the company's goodwill
- buildings
- machinery and equipment
- investments
Current assets are more short-lived that non-current assets. Current assets include:
- accounts receivable
- cash in hand and at bank, and
- inventories, such as finished products
The balance sheet values may deviate from the market value of buildings and machines, for example.
The liabilities side of the balance sheet
The liabilities side of the balance sheet consists of the company's equity capital and loan capital. Equity capital includes share capital, other funds, reserve for invested non-restricted equity and the profit or loss of previous financial years and the most recent full financial year. The equity capital is used to calculate, for example, the company's distributable assets that can be distributed to the shareholders as dividend. Loan capital includes loans from financial institutions, accounts payable and other debt.
Both sides of the balance sheet must be equal. If this is not the case, there has been an accounting error.
Interpreting the 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 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.
Balance sheet total
A company's balance sheet total is calculated by adding up the assets and liabilities. In other words, the balance sheet total means the amount of capital tied up in the company. As the business expands, the balance sheet total increases. A good balance sheet means that the company has good repayment capacity, in other words has enough cash, bank receivables and short-term receivables to cover current liabilities comfortably. A indicator of a good balance sheet is also that the equity capital is positive, that is, the sum of the current financial year's and previous financial years' profits combined with the sum of equity capital investments is higher than the amount of loan capital.
Ask your accountant to help you interpret anything that seems unclear on the company's financial statement, income statement or balance sheet. This will enable you to make decisions and plan for your company.
We interviewed Account Director Päivi Lehtilä from OP Lounaismaa for this article.
