The economic sub-positions of a company - financial, asset and earnings positions
Table of Contents
What are the three sub-layers/sub-positions?
The three terms - earnings, assets, and financial positions - are defined as the economic components of a company. Since they usually arise in connection with the preparation of the annual financial statements, the terms are assigned to external accounting. These three components are so important because commercial law requires a company to present a true and fair view of its economic situation in its annual financial statements. This requirement can be found, among other things, in Section 264 (2) of the German Commercial Code (HGB), the so-called general standard.
But what are the economic components, and how are they defined?
Earnings
In external accounting, income generally refers to all items that are crucial to business success. This means that important indicators of the earnings situation are the income generated during the financial year, such as income from rental payments or, more traditionally, sales revenue. However, expenses incurred also count towards the earnings situation, including wages paid, insurance contributions, and many more. These are summarized and compared in the income statement, so that at the end of the year it can be determined whether the company has made a profit or a loss. Since the profit and loss account, also known as the P&L account for short, is closed into the equity account at the end of the financial year, the earnings situation also provides information about the composition of and changes in equity, which is also referred to as net assets.
Assets
This refers to the reported assets and the overall ability of the company to continue to meet its business objectives in the future, i.e., primarily to ensure the company's continued existence. Assets are reflected on the assets side of the balance sheet. There, they are listed in descending order of liquidity. This means that the more liquid the assets are, the lower they are listed on the balance sheet.
Financial Position
The financial position is defined as all the financial resources that the company has at its disposal at the balance sheet date and that ensure that it can continue to meet the payment demands made by creditors on time in the future.
Problems in the Presentation of the Economic sub-layers
The annual financial statements cannot always or fully provide the picture required by Section 264 (2) of the German Commercial Code (HGB). Each of the economic sub-categories presents its own unique problem areas:
Earnings position:
The presentation in the annual financial statements is based on historical values and only considers actually realized business transactions. This proves particularly problematic when larger orders are received during the fiscal year, but based on the realization principle, these cannot be recognized as profits until final completion. As a result, larger expenses are often offset by lower income. Furthermore, information about future order books or research and development projects, also known as R&D projects, is not included in the annual financial statements.
Assets position:
Although the annual financial statements contain a list of assets, these are divided into fixed assets and current assets according to their respective commitment periods, as well as into tangible and financial assets. In concrete terms, this means that the assets are presented in aggregate form. Furthermore, the values listed in the balance sheet are historically oriented and therefore do not necessarily correspond to the actual fair value. Another point is that internally generated intangible assets (VG for short) of fixed assets are subject to the option under Section 248 (2) of the German Commercial Code (HGB) and therefore do not necessarily appear in the balance sheet. Intangible VG such as internally generated brands or advantages, however, may not be recognized by the company at all.
Financial position:
The financial position cannot be determined from the annual financial statements themselves; instead, a cash flow statement or financial plans are required. However, Section 264 (1) of the German Commercial Code (HGB) requires the preparation of a retrospective cash flow statement only for listed corporations. Further deficiencies include the failure to consider pending transactions and future payments that the company expects, and so-called liquidity reserves are not disclosed in the annual financial statements. All of the above reasons therefore ensure that the annual financial statements cannot provide any summary information about the company's financial situation. In this respect, corporations must add an appendix to their financial statements, detailing the results of operations, assets and financial position separately and thus giving the reader of the financial statements a better insight into both the balance sheet and the profit and loss account.
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