How to Prepare Your Annual Financial Statements – Here's the Right Way to Do It

As the new year begins, companies must focus on an important task: preparing their annual financial statements, which they use to disclose their financial situation to the tax authorities. Preparing these statements is a challenge for many organizations. Due to the immense amount of work involved, this process can sometimes take months. A lack of structure and traceability can lead to errors and an additional workload, which may delay completion. If, as a result, the financial statements are not filed on time and in accordance with regulations, this can have legal consequences. Adequate preparation is therefore essential to avoid problems.

Who is required to prepare annual financial statements?

According to Section 242(3) of the German Commercial Code (HGB), all companies required to use double-entry bookkeeping must prepare annual financial statements, including a balance sheet. These include, among others, AGs, GmbHs, and UGs. Sole proprietors must prepare annual financial statements if they have annual revenue exceeding 600,000 euros, total assets exceeding 350,000 euros, or employ more than ten people. Otherwise, a cash basis accounting statement (EÜR) is sufficient.

What components must an annual financial statement include?

The balance sheet and the income statement are the main components of the annual financial statements. Depending on the legal form and size of the company, other sections—such as the management report, notes to the financial statements, or the cash flow statement—may also be included. While the annual financial statements for sole proprietorships and partnerships consist only of the two components mentioned at the beginning, corporations must include notes to the financial statements and, in some cases, a management report as well.

By when must the annual financial statements be prepared?

The deadline for preparing the annual financial statements also depends on the size and legal form of the company and ranges from three to six months from the balance sheet date. According to Section 264(1) of the German Commercial Code (HGB), corporations must prepare their annual financial statements within the first three months following the end of the fiscal year. If the fiscal year corresponds to the calendar year, the deadline is March 31. For very small corporations, the deadline is six months, which corresponds to June 30 of the following year. It is essential to adhere to these deadlines. If a delay is imminent, an extension should be requested from the relevant tax office.

Preparing the Annual Financial Statements—Here's How to Do It Right

Financial statements must be prepared thoroughly. However, compiling the necessary documents takes a lot of time. Accordingly, work on the financial statements should begin as early as possible—approximately two to three months before the actual closing date.  

Companies that maintain proper accounting records throughout the fiscal year will not encounter difficulties when preparing their financial statements. If supporting documents are filed in a way that makes them easy to trace and accounts are posted accurately, deadlines can be met more easily, and the finance team can successfully complete the annual financial statements even while handling day-to-day operations. Furthermore, thanks to careful bookkeeping, companies can prepare interim financial statements as needed, which banks may request when evaluating loan applications. Since interim financial statements should also be viewed in the context of the previous year’s financial statements, they can always serve as an analytical tool for evaluating a company’s financial performance.

The benefits of good preparation are therefore far-reaching. The tasks that need to be completed are as follows:

Sorting and Recording Accounting Documents: Documents related to all income and expenses must be organized in a way that allows for easy tracking. Missing documents in the accounting records must be replaced, and corrections to invoices must be requested if errors are found.

Recording All Contracts: Business documents such as insurance policies, loan agreements, and employment contracts are an important foundation for the annual financial statements. They not only provide legal protection but also serve as an essential basis for the company’s financial reporting. Accordingly, they must be recorded during the preparation process.  

Recording Current Assets: Current assets are a company’s inventory. They should be recorded and listed as part of a physical inventory count. In addition to cash on hand and bank balances, current assets include items such as merchandise, operating supplies, and office supplies.

Recording of Fixed Assets: In fixed asset accounting, all tangible fixed assets—such as land or company buildings—financial assets—such as stocks—and intangible assets—such as software licenses—must be recorded so that their values can be determined as of the balance sheet date.

Calculating and Recording Depreciation: Missing fixed assets must be fully depreciated; damaged assets may be partially depreciated. In some cases, outstanding receivables may also be written off.

Accounting for Accruals and Deferrals: All figures in the income statement and balance sheet must be clearly attributable to a specific accounting period, such as the fiscal year. A distinction must be made between accruals and deferrals. While accruals represent services paid for that will not be received until the following year, deferrals represent revenue that will not be recognized as income until the following fiscal year.

Review of Receivables and Payables: All loans or personal loans with a term of more than one year must be reported by the accounting department. Payables that have been outstanding for more than five years and cannot be settled in the following year must also be listed.

Accounting for Accruals: Accruals are liabilities whose amount and timing are uncertain in the current fiscal year but are highly likely to be realized in the following year. They serve as a precautionary measure and must be recorded as an expense by the accounting department.

Creation of statutory and voluntary reserves: To ensure that sufficient equity is available to meet potential future challenges, some companies must set aside statutory and voluntary reserves. Unlike provisions, reserves are classified as equity rather than debt.

The steps mentioned do not necessarily have to be handled by the company’s in-house accounting department. It is possible to outsource the accounting tasks that must be completed as part of the annual financial statements. Accounting can be outsourced to external accountants or a tax advisor.

Once all internal and external preparations have been completed, the financial statements are prepared, a process explained in more detail in the next chapter. Here, too, the company has the option of outsourcing the process. In this case, an external tax advisor handles all necessary tasks, allowing the internal finance team to focus on its core business. In addition, the expertise of a tax advisor minimizes the risk of errors. Before the tax advisor begins preparing the annual financial statements, he or she holds a meeting with the company to identify opportunities for tax optimization and ensure compliance with tax regulations. After the meeting, all prepared documents can be handed over to the tax advisor.

Preparing Financial Statements – Here Are the Steps You Need to Follow

The preparatory steps mentioned above make it much easier to prepare the annual financial statements. Specifically, the following steps must be carried out during the preparation process:

1. Closing Main and Subaccounts: At the end of the fiscal year, all entries that were posted to various subaccounts for clarity must be consolidated into main accounts. To do this, the subaccounts must first be closed to determine their balances. When closing the accounts, a distinction is made between asset and income accounts. 

The balances of general ledger accounts represent the individual items on the balance sheet. General ledger accounts are divided into asset accounts and liability accounts. Asset accounts that must be closed include, among others, current asset accounts and fixed asset accounts. Liability accounts that must be closed include, for example, liability accounts and the equity account.

The closing balances calculated for the individual inventory accounts are then transferred to the closing balance account.

Income accounts are closed out through the profit and loss account. Income accounts are classified as expense accounts and revenue accounts. After the individual income statement accounts have been closed, the calculated balances are settled through the profit and loss account. The profit and loss account compares a company’s profits and revenues, thereby showing its performance during the past fiscal period. If the total of the debit side of the profit and loss account is greater than that of the credit side, this means that a loss was incurred. Otherwise, the company has generated a profit.

The next step is to close out the profit and loss account. This is done through the equity account. If there is a profit, the balance of the profit and loss account is transferred to the credit side of the equity account; if there is a loss, it is transferred to the debit side. Finally, the balance of the equity account is determined and transferred to the closing balance sheet account.

2. Preparing the Financial Statement Summary: Since the tax office may request the financial statement summary in addition to the income statement and balance sheet, it should be prepared at the same time as the balance sheet. The summary lists all opening and closing balances. This financial statement summary is organized by balance sheet and income statement accounts.

3. Review of the annual financial statements: Once the financial statements have been prepared, the documents should be reviewed in detail. If the review is conducted by an auditor, he or she is required to participate in the “approval” proceedings.

4. Approval of the Annual Financial Statements: Pursuant to Section 46(1) of the Limited Liability Companies Act (GmbHG), the annual financial statements of a GmbH are submitted to the shareholders or the shareholders’ meeting for approval. In the case of AGs, the responsibility for the approval process differs from this. As a rule, pursuant to Section 172 of the German Stock Corporation Act (AktG), approval is the responsibility of the executive board and the supervisory board, and only in exceptional cases of the annual shareholders’ meeting. As part of this formal procedure, the financial statements are approved by signature. If there has been a change in management during the preparation of the annual financial statements, the date of approval determines who must sign. If a new managing director is already in office at the time of approval, that person must sign the annual financial statements, even if they were not yet active in the company during the preparation phase.

Since 2013, once annual financial statements have been finalized and approved, companies required to prepare financial statements must submit them electronically to the appropriate tax office. This is done through the ELSTER portal.

These costs are incurred in connection with the annual financial statements

The costs associated with preparing the annual financial statements depend on whether the company prepares them in-house or outsources the work to a tax advisor. If the annual financial statements are prepared by the company’s own accounting department, the costs are based on the time required. There are payroll costs for the employees responsible for preparing the financial statements. In addition, there may be license or usage fees for software tools required for their preparation.

Costs also vary when it comes to outsourcing. They depend primarily on the amount of work involved for the tax advisor. Among other factors, the amount of work depends on how extensively the annual financial statements have already been prepared. The size and type of the company are also relevant in determining the costs, since the number of components that must be prepared for the annual financial statements varies depending on the company’s legal form.

In general, tax advisors work on a fee basis. The Tax Advisor Fee Schedule (StBVV) provides them with a framework for determining these fees. Tax advisors have some discretion in applying these fees. To calculate the range within which the fee may fall, the value of the matter must first be determined. For annual financial statements, this corresponds to the average of the balance sheet total and annual revenue. Based on the value of the matter, the corresponding full fee (10) can be found in Table B of Appendix 2 of the StBVV. Pursuant to § 35(1)(1a) StBVV, the discretion regarding the fee for preparing the balance sheet and income statement ranges from 10/10 to 40/10. This corresponds to costs ranging from the full fee specified in the table (10/10) up to four times the fee listed in the table (40/10).

For example, if a company has a value of 1,000,000 euros, this corresponds to a fee of 1,063 euros according to the table. Under the StBVV, the tax advisor may charge a fee ranging from 1,063 euros (10/10) to 4,252 euros (40/10) in this case.

Mistakes You Should Avoid When Creating It

There are a number of things to keep in mind when preparing the annual financial statements. The list of steps above provides a good guide for this. In addition, there are some common mistakes that occur regularly. Aside from insufficient preparation, these include, in particular, the following:

Failure to Comply with Retention Requirements: After annual financial statements are prepared, documents that are no longer needed may be destroyed. However, many accounting records are subject to a ten-year retention period. This period begins at the end of the calendar year in which the annual financial statements were prepared. The relevant documents may not be disposed of until this period has expired. Disposing of them too early may result in fines.

Incorrect Assessment of Company Size: Depending on a company’s size, different accounting obligations and legal requirements apply. If the company’s size is incorrectly assessed, those responsible are in violation of the principle of proper accounting. To avoid this, the company’s size should be continuously assessed.

Failure to Disclose the Balance Sheet by the Deadline: Depending on their size, companies must make their balance sheets available to the public. While small companies are only required to submit their balance sheets to the Federal Gazette, larger companies are subject to a disclosure requirement. This also includes notes to the financial statements, the completeness of which is verified by the Federal Gazette. With regard to the disclosure requirement, there is a deadline of twelve months after the end of the fiscal year, which must be strictly adhered to. Failure to comply with this legal requirement may result in the Federal Office of Justice initiating administrative fine proceedings. Unlike when preparing the annual financial statements, no extension of this deadline may be requested. However, the Federal Office of Justice has the authority to grant special exemptions in exceptional cases, such as extraordinary burdens. This was the case in 2022, when the deadline for disclosing annual financial statements with a balance sheet date of December 31, 2022, was extended from December 31, 2023, to April 2, 2024. This extension was prompted by the economic impact of the COVID-19 pandemic on businesses.

Incorrect Structure: The components of financial statements must be arranged according to a specific structure. For example, Section 266 of the German Commercial Code (HGB) governs the structure of the balance sheet, which, among other things, requires that certain orders be followed for asset and liability items. If the order does not comply with the requirements, the tax authorities may reject the financial statements.

Missing Information: When compiling information for the annual financial statements, certain items may be overlooked or forgotten. Examples include missing information on provisions, collateral, or interest on debt. Signatures are also frequently omitted. A checklist can help prevent any potential consequences.

Conclusion

Preparing annual financial statements is a key task for companies. Thorough preparation and precise execution are essential to ensuring a successful outcome. To streamline the process, companies should spread the work involved in preparing the financial statements out in stages throughout the year. Software that enables the digitization of accounting processes is also helpful. This saves time during the final phase of preparation and helps prevent problems. It also avoids peaks in workload and ensures that companies are ready to close their books at any time throughout the year. Alternatively, both the preparation and the compilation of the annual financial statements can be outsourced to external service providers.