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How to read the Annual Financial Statements of a Romanian company

Updated: Dec 27, 2023

First of all, I should understand what the Annual Financial Statements are, if they are important for my company - and if they are of potential interest for others as well. My company's Annual Financial Statements are like a business card: they represent the company in front of an investor, a bank, a public authority. They reflect the work of one year - and the results that the company has achieved, both in that year and since the beginning of the activity.

Book cover with the words "How to read Annual Financial Statements Romanian Company"

var annualFinancialStatements: Bool = true

The Annual Financial Statements include several components:


The Balance Sheet

 

The Balance Sheet represents the assets and liabilities, meaning the goods, cash and debts that I have in the company. The Balance Sheet is based on the final values from the trial balance, where the assets and liabilities are found. When I have a Balance Sheet in front of me, it is interesting for me to look at the following elements: in the category of assets I find goods, fixed assets, inventories, cash; in the category of liabilities I find, in the mirror, the sources that generate these assets: debts under one year, over one year. I also find equity as a financing source of these assets. The higher the share of equity compared to liabilities, the more stable the company is, allowing me to go further with it, to do business.

What does the Romanian word “Activ” actually mean in Romanian accounting?

Activ” means assets: fixed assets, i.e. tangible and intangible assets. Intangible assets mean licenses, goodwill, software, patents, buildings, cars, equipment - all goods that have a useful life of more than one year and a value of more than RON 2 500. Inventories are also asset accounts: merchandise, raw materials, materials I need to operate. The receivables - everything I have to collect - are also assets: trade receivables - from customers; VAT receivable; advances from suppliers that are not completed; employees’ imputations. The cash from the cashier and from the bank accounts is another example of an asset, as well as the amounts paid in advance for various services I receive in a specific interval - mandatory liability insurance, optional insurance, subscriptions, consulting services for a period of more than one year.

What does “Pasiv” mean in Romanian accounting?

The “Pasiv” represents, in the mirror, the sources of funding for the assets: liabilities and equity. Assets, on one hand, and liabilities plus equity, on the other, are always equal. The “Pasiv” includes debts - which can be under one year or over one year. The category under one year includes payment obligations to suppliers; remaining leases for payment under one year (these represent a debt until the end of the leasing contract); bank loans under one year - if I took loans to finance my assets, to pay employees, for the development needs of the company. The category over one year includes payment obligations to suppliers; leasing rates exceeding one year; bank loans over one year - if I took loans for the development needs of the company. Also included in the “Pasiv” are the salary obligations - to the employees and to the state budget.


Equity itself is also part of “Pasiv”. This represents the added value of the company: the share capital, the reserve funds that I built from profit - meaning that I did not withdraw dividends, but left the profit in the company. When I do not cash out the profit and leave it instead as a reserve in the company, this company will grow, it will be stronger, because it has the cash on which to support its growth - and it does not have to permanently borrow, it is not fuelled by ever-larger debts and by supplier credit, meaning from the unjustified delay in the payment of invoices received from suppliers. The higher the equity value and the lower the debt, the stronger is the company. It will be able to run the business, to hire new employees, to continue developing. The more the company feeds on loans, the longer the treasure hunt will last, turning into a fata morgana. When I see that debts are starting to be overwhelming, it is a good idea to stop borrowing. In the absence of a research and development component, lacking investment and added value, if I am a service provider that becomes more and more stuck in debt, I may not reach through.

Case study: a Romanian company signed a contract on very good terms, with a partner from abroad, for the purchase of products. The Romanian business owner was satisfied with just going only to a number of malls, offering them the products - and waiting for them to pay. In order to cover its financing needs, the company took out loans - thus practically sponsoring the respective shopping centres: instead of those shopping centres themselves taking loans, this company itself took out loans, borrowing and losing on its margin, i.e. the resale value minus the purchase value. The margin got reduced so much that it became less than even the costs: development, acquisition, storage, salaries, management, distribution, presentation, rent, shelf. This eventually led the company to bankruptcy. Every such lesson I receive must be understood and not repeated.

Retained earnings are, in turn, a useful resource, but only when the company is stable. In case of a loss, it is deducted from equity.


var balanceSheet: Bool = true


The Profit or Loss Account

 

The Profit or Loss Account is another important financial statement, in which I find the revenue and expenses presented in detail, classified by categories. The revenue represents everything I invoiced, without VAT or other taxes - the net income I made. In the revenue, I find everything that means services - if my company is a service provider - or the value of the goods I sold, i.e. income from the sale of goods - if my company is active in the field of trade. The discounts I granted are deducted from the revenue. I always find the total net income in the revenue.

The revenue, in the annual financial statements, is composed of operating revenue, financial revenue and investment revenue.

The operating revenue comes from the main activity of the company. The financial revenue comes, for instance, from exchange rate differences, if I have receivables or cash in foreign currency. The difference in value between the invoicing date and the date of receiving the money, if the exchange rate is advantageous to me, will represent a financial revenue. The financial revenue also includes bank interest from deposits, meaning income I obtain from the placement of cash.

When I have cash in the current account of the company, the advice is to make a deposit with it, to benefit from a better interest rate on the deposit account than on the current account.

The expenses, in a mirror, are composed of operating expenses, financial expenses and investment expenses.

Operating expenses include expenses with raw materials, cost of goods, what I used to produce, energy, water. The difference between the revenue from the sale of goods and the expenses for the sale of goods is my gross margin, to which I must always pay attention because from this margin I have to also cover other costs. If all my operating expenses exceed this gross margin, then my company has a loss.

Operating expenses also refer to expenses with services - maintenance, repairs, travel, telephony, insurance - as well as personnel expenses, which include the gross salaries plus the Labour Insurance Contribution, abbreviated CAM (=ro. Contribuția Asiguratorie pentru Muncă) - and the expenses with the collaborators.

Regarding depreciation, this means the inventory value of fixed assets recovered as cost, in the expenses. Taking the example of a car, its value is not classified entirely as an expense, from the beginning: instead, it is divided into equal monthly tranches; for example, if the depreciation period is 4 years, I am looking at 48 monthly instalments. The accumulated value is found in Expenses with the depreciation of fixed assets.

Another Balance Sheet element: the adjustments - trade receivables, receivables that I can no longer collect because I was not careful when I made contracts with customers, they went bankrupt, the receivables expired. For example, in the Balance Sheet I might have RON 1 000 of receivables, but, in fact, I can really only expect to collect RON 500. Therefore, in the Balance Sheet, I have to reflect only RON 500 as a trade receivable. For this, I have to make an expense - an adjustment of trade receivable. This kind of situation, especially if they are multiple - or if they have a high value - affects my profit: in previous years I projected a certain profit, but when I find that, in fact, I will not be able to actually receive the money, I will have an expense with this amount, thus diminishing my profit.

There are other operating expenses as well, for example with the sale of fixed assets, or the transfer of expired receivables to expenses, or sponsorships.


Operating revenue minus operating expenses results in operating profit if operating revenue is greater than operating expenses, or operating loss if operating expense is greater than operating revenue. The operating profit reflects how profitable my activity was in that year; in other words, what I earned as added value compared to the work and resources I dedicated to the company's activity.

I need to analyse the cost of goods and revenues from the sale of goods, which, for a trading company, are some of the most important indicators. The difference between the revenue and the cost of the goods - i.e. the purchase price from the suppliers - is, in fact, the gross margin, from which the company begins to cover its expenses. If expenses exceed revenue, the company is at a loss.

Financial revenue and expenses are also important components of the income statement. The difference between them leads to financial profit or financial loss. It is very important for companies that have business relations in foreign currency - meaning they use a substantial amount of foreign currency in their activity, they make foreign payments, they make purchases from abroad that they have to pay - to realise that the exchange rate difference plays an important role in their Profit or Loss Account, as well as on the cashflow side. In this case, it is good for me to keep foreign currency in my account - or to foreign buy currency when the currency exchange rate is to my advantage. I can also negotiate more generous payment terms so that I can use the longer time frame to identify the most appropriate time for currency conversion and payment. When I have foreign currency available, I do not have to borrow or buy it at disadvantageous prices. It can also be useful to have an overdraft line of credit, for which I do not pay interest or commissions if I do not use, but which I can rely on in an emergency.


The Profit or Loss Account is the place where revenue and expenses are reflected, where I can analyse how efficient my activity was and how profitable, what measures I can take to increase profitability next year.


I often hear about tax value and book value. These are two different notions: the book value represents the value that I can operate in accounting. For example, I bought a car for which I gave RON 100 000 - and I do not want to deduct it from the accounting, that is, to have a higher profit, but I want to recover it in a year and I simply classify it as an expense of that year; instead of making a profit of RON 200 000, I wanted to recognise the full value of the car, of RON 100 000, as an expense - and I still have a profit of RON 100 000. However, fiscally, the Tax Agency does not allow me to deduct it in full, for the entire amount of RON 100 000; instead, from the tax point of view, I need to depreciate it in a period between 4 and 5 years. That is, I will have a monthly depreciation expense, affecting my Profit or Loss Account.


var bookValue: Int = x
var taxValue: Int = y
var marketValue: Int = z


The Form Informative Data

 

The Form Informative Data is the place where I find the details of the amounts from the Balance Sheet, regarding suppliers, debts, trade receivables.


Recently, the tax authorities have started to make analyses based on these pieces of information, such as, for example, how much shareholder loan do I have in the company - or what is the cash balance. Based on this information, I may have the surprise to be visited by the tax inspectors and asked about the cash I transferred to the petty cash account. The tax authorities have access to financial information, and they are focusing on companies that have a large balance in the petty cash account, anticipating that the money is not actually there. If, for example, I finalise the year with a cash balance of RON 700 000, while the revenue was RON 800 000, this is a risk signal for the Tax Agency, which will suspect undeclared revenue or dividends withdrawn for which I did not pay dividend tax. Two cases: the money is, indeed, in the cashier's - or not. If the money is not in the cashier's, the Tax Agency will “confiscate” the respective money: it will not actually take it from my account, but will make a report and will pass it to me as an obligation to pay tax in the taxpayer’s sheet: profit tax, VAT etc. The Tax Agency will calculate the tax on dividends, with interest, penalties and charges, from the first moment since I cashed money from the firm. Every month, the Tax Agency will issue a tax imposition decision and will block my money that it did not find in the cashier.


The value of shareholder loans is also a piece of information carefully analysed by the tax authorities. They verify whether, in the case of a company that has revenue of RON 800 000, for instance, while having RON 2 000 000 in its accounts, the shareholders have declared their income from dividends or other sources in the Consolidated Tax Form; after that, the tax inspectors can request information from the company: loan contracts, proof of the sources of money, all supporting documents. A couple of scenarios: A) when the tax inspectors discover that these loan agreements and supporting documents do not exist, they consider that the difference between the revenue and the money in the account cannot be proved; B) if those loan agreements are with relatives or friends, but the money cannot be proved, the tax inspectors will analyse the Consolidated Tax Form of the respective persons. If the Tax Agency does not identify these amounts as income for the lenders, it will consider this situation as an indication of money laundering, tax evasion - and will calculate VAT and profit or income tax on the micro-enterprise.



The Assets Register (Tax Form 40)

 

In this form I can find fixed assets, tangible assets, intangible assets, licenses, software, buildings, land, equipment, furniture - detailed by groups of fixed assets, at the value of acquisition - or at a revalued amount, if I revalued them - and depreciation, similarly, calculated by groups. In the form I will find the value at the beginning of the year (meaning the value with which I finished the previous year) plus entries (meaning what I purchased) minus outflows by sale or scrapping - and what is left at the end of the year. The difference between the inventory value and the calculated depreciation represents the remaining value, a deductible expense, element of the Profit or Loss Account, which I will recover in the next period from the revenue obtained.


There are also a number of addenda to the financial statements, which must be prepared by the administrator and verified by the accountant. For example the Decision of the General Shareholders’ Meeting for approving the Financial Statements; the Supplementary Notes to the Financial Statements; the Administrator's Report; the Administrator's statement of compliance with all accounting principles when preparing the Financial Statements.


The Decision of the General Shareholders’ Meeting

 

The decision of the General Shareholders’ Meeting (=ro. Hotărârea Adunării Generale a Acționarilor, AGA) approving the Financial Statements is mandatory for the shareholders. It is important that this meeting actually takes place: in addition to the formal, ceremonial side of this meeting, it also helps in the communication between the associates, both regarding the year ended and the current one.


The generic format of this AGA Decision includes elements such as: the General Meeting of Shareholders was convened on dd.mm.yyyy; AGA has approved the Financial Statements and the Administrator’s Report; the profit obtained was placed in the category of retained earnings - or distributed as dividends.


When a conflict arises between associates, any document can become evidence in court.


I must take into account the following details when approving the Financial Statements and distributing the profit: if I have made investments in fixed assets that still generate outflows, I do not have to distribute all my profit on dividends. I have to keep a resource in the company with which to cover the remaining part of the investment, otherwise, I will be indebted. I have to be as thoughtful as possible, to keep the profit made in the category of retained earnings. Only when I have made a profit that exceeds the remaining value of the investment which still needs to be covered is it time to start thinking about withdrawing as dividends the difference between the profit obtained and the remaining part of the investment. When I leave the profit in the retained earnings category, I can subsequently distribute the profit on dividends at any time during the year, through an Extraordinary Shareholders’ Meeting, then collect the dividends and pay the dividend tax. If I fully distribute the profit on dividends but fail to collect them in full by the end of the year, then I am required to pay the full dividend tax by the end of the following year. I will not be able to return to an already approved AGA Decision, I will not be able to change it.


if profitEntirelyDistributedAsDividends = true && dividendsCollectedUntilYearEnd = false {
 pay dividendTax
}

It is not fair to distribute the profit towards the reserve fund, for development, and, after years - when the company is stable due to the cash available at the right time - to return to the AGA Decision and to modify it with a new AGA Decision by which I change the destination of the profit from the reserve fund into dividends. The Companies Law does not allow this.


The Notes to the Annual Financial Statements

 

In the Balance Sheet are only the numbers distributed by categories, without too many details. The Notes to the Annual Financial Statements present information on the company's accounting policies, detailed information on all elements of the Balance Sheet and of the Profit or Loss Account, at the account level.


For example, in the case of fixed assets, I can find comparative information: “compared to the previous year, the value of fixed assets increased by x RON, due to the purchase of a [computer]/[vehicle]”.


Anyone interested can consult this information: investors or other people who want to get information about the company.

In the Notes to the Annual Financial Statements, there is also a very important piece of information: the companies that have transactions with related parties have the obligation to enter in the Notes to the Annual Financial Statements information on these transactions.


The Administrator's Report

 

The Administrator's Report is, in turn, an element of the Financial Statements, through which the administrator justifies activity at the end of the year and details the results obtained - which must be in accordance with the rest of the documents in the Annual Financial Statements, containing the same information.


The Administrator's Report is a document that the auditor needs to see, analysing the extent to which the document complies with company policies and is consistent with the Annual Financial Statements.


The Administrator, in this Report, also presents the company's strategy in the next period, showing if it respects the principle of continuity.



The Administrator's statement of compliance with all accounting principles when preparing the Financial Statements

 

This is a requirement under the Accounting Law (Law 82/1991, Article 262). In my role of Administrator, I must assume responsibility for the preparation of the Annual Financial Statements and confirm the following:


a) the accounting policies used in the preparation of the Annual Financial Statements are in accordance with the applicable accounting regulations;

b) the Annual Financial Statements provide a true and fair view of the financial position, financial performance and other information relating to the business;

c) the legal person carries out its activity in conditions of continuity.


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In conclusion, the Annual Financial Statements are a company's business card and a useful source of tax optimisation.

There is a perception that the Annual Financial Statements are simple exports from the accounting software, which are then just uploaded to the Tax Agency’s platform and that is everything there is to it. This vision loses sight of the opportunities for analysis offered by reading a set of Annual Financial Statements with the understanding of what they actually comprise: a diagnosis of the company, in a standardised form, which allows comparisons between several elements within the company, for example over several years - or comparisons between several companies at the same time.


All items included in the Annual Financial Statements blandly present its financial standing. Financial Statements are a photograph of the firm at a certain point in time, useful to present to an investor or future associate. A business card. Just as I would not want to go to an important meeting without a business card, or with a crumpled one, or with mistakes on it - identically I have every interest in the Annual Financial Statements being prepared correctly, with quality, and on time.


The Annual Financial Statements represent the business card of my business in Romania. Once I understand this, my business will be secure, because I understand my business mechanisms and translate them into a series of documents and numbers that express the reality of operations: my activity generates products or services at a specific point in time, while the accounting documents remain for the entire life of my company - and even after -, to express a realistic, independent opinion on how I conducted my business.


It is a good idea, therefore, to value the documents I have, the information these documents contain. I will need these documents in various cases: for a new contract, for a loan. They will help me when I least expect it. And one of the cases in which I will need them is the one in which my business in Romania is part of a multinational holding, in which the financial reports are prepared according to the International Financial Reporting Standards (IFRS).


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ℹ️ Tax optimisation opportunities are triggered at certain moments in time. There are, however, two factors that I have to pay constant attention to, because the overall value of my company depends on them: cash - and equity.

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