Understanding Annual Financial Statements

Financial statements provide a snapshot of a company’s financial position and performance over a specific period. They are crucial for making informed decisions, attracting investors, securing loans, and ensuring compliance.

In this article, we explore the three primary components of financial statements: the balance sheet, income statement, and the notes. We delve into the various elements of each and explain their significance for startups. Additionally, we discuss important considerations, including regulatory requirements, tips for preparing, managing, and utilizing financial statements, their practical applications, and common mistakes and misconceptions to avoid. Let’s dive in.

What are the Swiss financial reporting standards?

The Swiss Code of Obligations (CO) sets the framework for the preparation and presentation of financial statements in Switzerland, including the balance sheet, income statement, and the notes. Additionally, there are two major sets of accounting standards which are generally followed by larger public corporations. These are the Swiss generally accepted accounting principles (Swiss GAAP FER) and the International Financial Reporting Standards (IFRS).

These standards ensure transparency and consistency of financial statements, while adapting in their level of stringency to cater to the needs of various business sizes, from small enterprises to large corporations. For startup founders, understanding these standards is crucial for compliance and strategic financial planning.

What are financial statements?

Financial statements are formal reports that summarize the financial performance and position of a business. They provide information on the revenues, expenses, assets, liabilities, and equity of a business over a specific period, typically a fiscal year. Financial statements are used by various stakeholders, such as investors, creditors, regulators, and managers, to evaluate the financial health and prospects of a business.

The three main components of financial statements are:

1. The balance sheet
2. The income statement
3. The notes

We will explain each of these financial statements in turn by first providing a brief definition, then outlining its main components, and finally discussing its importance for startups.

The Balance Sheet

What is the balance sheet?

In simple terms, the balance sheet outlines what a business owns, owes, and how much it is worth. It provides a snapshot of a company’s financial position at a specific point in time by summarizing its assets, liabilities, and equity. The balance sheet reflects the accounting equation: Assets = Liabilities + Equity.

What does the balance sheet contain?

In the balance sheet, the assets (Aktiven) and liabilities (Passiven) of a company are compared. For precise representation, the assets are further divided into current assets (Umlaufvermögen) and non-current assets (Anlagevermögen).

Aktiven (Assets)

Current Assets (Umlaufvermögen)

Definition: Assets expected to be converted into cash or consumed within one year.

Examples:

• Cash and cash equivalents: Cash, bank balances, and short-term investments.
• Accounts receivable: Outstanding invoices from customers.
• Inventory: Raw materials, work-in-progress, and finished goods.

Non-current Assets (Anlagevermögen)

Definition: Assets available to the company long-term (more than one year) providing long-term economic benefits.

Examples:

• Property, plant, and equipment: Land, buildings, machinery, and technical installations.
• Intangible assets: Patents, licenses, trademarks, and goodwill.
• Financial assets: Long-term investments, loans, and other long-term financial investments.

Passiven (Liabilities)

Liabilities are obligations that the company must settle in the future, usually by transferring assets and sometimes by providing services. They are divided into current and long-term liabilities, depending on when the company expects to settle them.

Current Liabilities (Kurzfristige Verbindlichkeiten)

Definition: Obligations expected to be settled within one year.

Examples:

• Accounts payable: Money owed to suppliers for goods and services received on credit.
• Short-term debt: Loans and credits due within one year.
• Accrued expenses: Costs incurred but not yet paid, such as wages and benefits.
• Deferred revenue: Payments received for goods or services not yet delivered or performed.
• Taxes payable: Taxes owed to the government that are yet to be paid.

Long-term Liabilities (Langfristige Verbindlichkeiten)

Definition: Long-term obligations due after one year.

Examples:

• Long-term debt: Loans and bonds due after one year.
• Deferred tax liabilities: Taxes accrued but payable in a future period.
• Other long-term obligations: Other liabilities not due within the next year, such as pension obligations or long-term lease commitments.

Equity (Eigenkapital)

Equity indicates the value of the company. In other words, it is the remaining share of the owners in the company’s assets after deducting liabilities, calculated by rearranging the accounting equation:

Equity = Assets – Liabilities

Equity includes:

• Share capital: Funds raised by issuing shares to investors.
• Retained earnings: Cumulative profits retained and reinvested in the company rather than distributed as dividends to shareholders.
• Legal reserves: Reserves that must be created by law.
• Voluntary reserves: Reserves created beyond legal requirements.
• Capital reserves: Capital contributed by issuing shares above their nominal value.
• Treasury shares: Shares repurchased by the company.

Why is the balance sheet important for startups?

The balance sheet is crucial for startups as it acts as the primary indicator of a business’s overall financial stability and health. It provides insights into the company’s short-term liquidity, long-term solvency, and capital structure (mix of debt and equity financing). These insights are essential for making informed business decisions, securing financing from creditors, and attracting investors.

The Income Statement

What is the income statement?

The income statement, also known as the profit and loss statement, summarizes the revenues and expenses incurred during a specific period, usually the financial year. It measures the profitability of a business by subtracting the total expenses from the total revenues to calculate the net profit (or loss) for the period.

What does the income statement contain?

1.    Revenues

Revenues represent the income earned from business operations, such as the sale of goods and services. Revenues include:

• Sales revenue: Core income generated from selling products.
• Service revenue: Income earned from providing services.
• Other income: Other non-operating income, such as interest income, rental income, proceeds from the sale of assets, etc.

2.    Expenses

Expenses represent the costs incurred during business operations to generate revenues. They include:

• Cost of sales: Also known as Cost of Goods Sold (COGS), these are the costs directly related to the production of goods or services sold by the company, such as raw materials, direct labor, and manufacturing overheads.
• Operating expenses: Operating expenses are the costs required to run the company’s core business operations excluding direct cost of sales. These include:
  • Sales and distribution expenses: costs related to selling and distributing products such as marketing and advertising, shipping and delivery expenses, warehousing costs, commissions for sales staff, etc.
  •  General and administrative expenses: Overhead costs such as salaries, rent, utilities, maintenance costs, etc.
• Depreciation and amortization: Non-cash expenses that allocate the cost of tangible (depreciation) and intangible (amortization) assets over their useful lives.
• Interest and taxes: Interest payments on borrowed funds and taxes owed to the government in accordance with the company’s taxable income.

3.    Net profit or loss

Net profit or loss is the bottom line of the income statement, calculated as revenues minus expenses. It indicates the company’s overall profit (when revenues are greater than expenses) or loss (when expenses exceed revenues) over the reporting period.

Why is the income statement important for startups?

The income statement is important for startups because it provides information on their overall profitability and shows how successful they have been in generating revenues and controlling expenses. This helps founders evaluate their business model, identify their main sources of income and expenditure, and look for opportunities to improve their profitability. The income statement is also used by investors, lenders, and other stakeholders to assess the startup’s current financial performance and potential for future profitability and growth.

The Notes to the Financial Statements

The notes to the financial statements supplement the balance sheet and income statement by providing additional information and explanations essential for understanding the company’s financial position and operations. In Switzerland, companies are required to include the following in the notes:

• Explanation of the applied accounting and valuation methods: These details clarify how the various items in the balance sheet and income statement were valued and recorded.
• Disclosure of off-balance sheet liabilities: This includes contingent liabilities and other financial commitments not reflected in the balance sheet.
• Explanation of significant balance sheet and income statement items: Detailed breakdowns of important items such as receivables, liabilities, and provisions.
• Transactions with related parties: Information on transactions and dealings with shareholders, management, or other related parties.
• Significant events after the balance sheet date: Important events occurring after the balance sheet date that could significantly affect the company’s financial position and performance.
• Details of participation in other companies: Information on the company’s investments in other entities, including the nature and extent of these investments.
• Statement on compliance with legal requirements and accounting standards: Confirmation that the financial statements comply with legal requirements and recognized accounting standards.
• Disclosure of significant risks and uncertainties: Information on major risks and uncertainties that could affect the company’s future development.

These notes ensure transparency and enhance the comprehensibility of the company’s financial reporting.

The Cash Flow Statement

What is the Cash Flow Statement?

In Switzerland, companies required by law to undergo an ordinary audit must prepare a cash flow statement and a management report as part of their annual financial statements.

The cash flow statement provides an overview of cash inflows and outflows from operating, investing, and financing activities during a period. It shows how changes in the balance sheet and income statement affect the company’s liquidity position (cash and cash equivalents).

What is the difference between the Cash Flow Statement and the Income Statement?

The difference between the cash flow statement and the income statement is that the cash flow statement measures the actual movement of cash in and out of the company, while the income statement reports revenues and expenses on an accrual basis, which may not coincide with the timing of corresponding cash transactions.

Why is the Cash Flow Statement important for start-ups?

The cash flow statement is crucial for start-ups as it provides insights into the company’s liquidity and cash management. It helps companies determine and optimize their liquidity position to ensure sufficient cash is available to meet obligations and invest in growth opportunities.

The cash flow statement is also valuable for potential investors and creditors as it indicates whether the start-up can sustain its growth, ensure long-term solvency, and timely repay debts and other obligations. A positive cash flow suggests the start-up can maintain operations and invest in future growth, while a negative cash flow may indicate liquidity issues that need to be addressed.

What are the key regulatory requirements for Swiss startups?

Startups must understand the key regulatory requirements pertaining to their annual reporting obligations, auditing requirements, and tax filing responsibilities.

Annual Reporting Requirements

Swiss start-ups must prepare annual financial statements in accordance with the Swiss Code of Obligations (OR). This includes the balance sheet, income statement, and notes. Companies subject to an ordinary audit must also prepare a cash flow statement and a management report.
Depending on the size and legal form of the company, start-ups may use simplified accounting methods for their financial statements. For more details, please refer to our article on the special features of bookkeeping for an LLC.

Auditing requirements

Depending on the size and structure of the startup, an audit may be required. Most small and medium-sized businesses only require a limited audit or, in some cases, can opt out of the audit entirely. Larger companies generally require a full ordinary audit by an independent auditor.

Tax filing responsibilities and deadlines

One of the main purposes of preparing annual financial statements is to aid in filing taxes and provide supporting documentation for the tax returns. Swiss companies must adhere to federal and cantonal tax regulations, which includes corporate income tax filing, value-added tax (VAT), and social security contributions. Timely and accurate filing and payment of taxes is essential to avoid penalties and take advantage of tax deductions and credits.
Read our recent article, Tax Crash Course for Startups, for a comprehensive rundown of everything Swiss startups need to know about their tax obligations.

Tips for preparing, managing and utilizing financial statements

Tip 1: Use accounting software

If you’re handling your own financial reporting, it’s worthwhile investing in accounting software to help streamline the preparation and management of your financial statements. Software can automate calculations, generate reports, and ensure greater accuracy. Popular accounting software options in Switzerland include Microsoft Dynamics 365 Business Central, Abacus, Infoniqa (formerly Sage), and Bexio.

Tip 2: Hire a professional accountant

While accounting software can be useful, hiring a professional accounting provider can provide valuable expertise, especially for more complex accounting needs. A professional accountant ensures compliance with regulatory requirements, provides greater accuracy and streamlining of your financial reporting, and offers expert advice on financial matters.

Tip 3: Regularly review your financial statements

Conduct regular reviews of your financial statements to monitor performance, identify trends, and make wiser decisions. Your financial statements shouldn’t be filed in some folder and never looked at again. They provide valuable insights into your financial situation and can help you understand where you can better improve your income generation and cash flow, mitigate against potential risks, and optimize your business strategy.  

Tip 4: Analyze your performance using trends, ratios, and benchmarking

When reviewing your financial statements, use financial ratios and benchmarks to analyze your startup’s performance against industry standards and competitors. Key ratios to monitor include:

• Current ratio: Measures your startup’s ability to meet short-term obligations with its current assets. A ratio above 1 indicates good liquidity.
• Debt-to-equity ratio: Assesses your startup’s financial leverage by comparing its total liabilities to its equity. A lower ratio indicates lower financial risk.
• Gross profit margin: Indicates the percentage of revenue that exceeds the cost of goods sold, reflecting your company’s profitability.

Tip 5: Plan for tax obligations

Use your financial statements and work with your accountant to keep track of your expected tax liability. This can help you stay proactive in tax planning and thus optimize your tax position while ensuring compliance with all tax obligations.

Tip 6: Stay updated on regulatory changes

Regulations governing financial reporting and taxation change regularly, impacting your business’s compliance requirements. Stay informed about any changes in Swiss accounting and tax regulations and adjust your financial reporting practices accordingly.

Avoid these common mistakes and misconceptions

Don’t fall into the trap of making any of the following common mistakes and misconceptions about financial statements:

Misinterpreting financial statements

It can be all too easy to misinterpret the facts and figures of your financial statements. With limited accounting and financial knowledge, you may misidentify key trends, incorrectly calculate performance ratios, and draw mistaken conclusions about your financial situation. Therefore, it’s vital to work with an experienced accountant or financial advisor. This helps ensure a proper understanding of your financial statements and thereby avoids making flawed business decisions.

Ignoring qualitative information

The quantitative information contained in your financial statements can be an excellent tool for better understanding your startup’s situation and guiding your business strategy. However, you should always keep the bigger picture in sight by also considering relevant qualitative factors, such as market conditions and competitive landscape, alongside quantitative financial data. This gives a more meaningful interpretation of what the figures in your financial reports show, resulting in better insights.

Overlooking cash flow

A common misconception when examining financial statements is that profitability always equates to financial prosperity. However, being profitable is just one ingredient to having a successful and sustainable business. If you only focus on the income statement but fail to pay attention to cash flow management, you risk running into liquidity issues that could jeopardize the startup’s operations.

What are some practical applications of financial statements?

Financial statements serve various essential purposes and are used in many different contexts. Here are some of their most useful practical applications:

Supporting liquidity planning: Financial statements, particularly the cash flow statement, help in planning liquidity needs, ensuring the startup can meet its short-term obligations and invest in growth opportunities when they arise.

Informing business decisions: Financial statements provide valuable insights that aid in strategic decision-making, such as budgeting, pricing, and investment planning.

Guiding investment strategies: Financial statements, particularly the balance sheet, can be useful in evaluating the viability of investment opportunities for the business. Additionally, they can attract potential investors to the startup by demonstrating financial stability and growth potential.

Determining creditworthiness: Lenders and creditors closely assess the financial statements to determine the startup’s creditworthiness and ability to repay loans. Of particular importance is the balance sheet which indicates how highly leveraged the business is, and the cash flow statement which indicates the startup’s ability to fulfil its short-term payment obligations.