How to analyse financial statements 2020

Can you remember what you did on New Year’s Eve 2019? Maybe you were preparing yourself for a carefree and convivial evening with friends and family when, around 11:04 AM the Chinese central government reported the occurrence of a mysterious lung disease in the province of Wuhan with 27 infected persons.

One thing already seems to be clear: the year 2020 will remain anchored in our collective memory, and future generations will probably learn about it in lessons on history or politics. In this article, however, we would like to shift the focus from the health and emotional impacts to the economic consequences of 2020 and the impact on annual reports from that year.

Lockdown, short-time working allowance and immediate corona support payments – the 2020 financial year was more than unusual.

A look back: At the start of the year, the risk of the virus spreading in Germany was regarded as minimal, but pictures from northern Italy and reports of increased incidences of the coronavirus in Germany, especially in North Rhine-Westphalia, Bavaria and Baden-Württemberg, showed how completely unprepared the German health system was to handle such a threat and on 22nd March finally led to agreement between the federal and state governments regarding strict limitations on contact and freedom of movement.

As a result of these limitations, millions of employed people could no longer go to work – the economy came to a standstill. The government swiftly agreed on an extension of the short-time working allowance and put immediate corona support payments into place. The public debate focused, among other things, on whether the state should come to the aid of companies in difficult economic waters and provide them with liquidity.

The German airline Lufthansa, which reported at the beginning of April that around 95% of its flights would have to be cancelled due to corona, was perhaps the most prominent example in this debate and on 25th May was granted a state support package worth billions of euros before exiting the DAX for the first time on 4th June. These events were followed by an almost relaxed summer, which felt surprisingly "normal". This feeling came to an abrupt end in the autumn when a new "partial lockdown" was put into effect on 2nd November.

Before we look at the consequences of these economic changes for the evaluation of balance sheets, we would like to present two government aid schemes as examples of how such things should be treated in terms of bookkeeping:

Thanks to the short-time working allowance, from March 2020 onward German companies had the possibility to reduce their personnel costs without the necessity for mass redundancies. From an accounting perspective, the employer acts as a trustee who simply transfers the short-time allowance to his employees. The result is a reduction of the personnel costs without any complimentary payments appearing in the income statement.

It should be noted, however, that the employer's contributions to social insurances are handled differently. These continue to appear as costs in the income statement but are later refunded by the Federal Employment Office (Bundesagentur für Arbeit) and booked as other operating income.

The so-called "immediate corona support payments" are treated in a similar way. These were available from 13th June to support companies and self-employed people who suffered enormous financial pressure and lack of liquidity due to the pandemic. This immediate aid appears on the balance sheet in the same way as the employer's contributions to social insurances: as other operating income.

It is therefore important to note that the support payments as compensation for the decline in turnover due to corona are not compiled as turnover but as other operating income. Furthermore, it should be observed that due to the lengthy approval and evaluation procedures, the payouts of the corona support may have taken place in instalments, which means that liabilities may have been created until the date of formal approval. This date is therefore decisive in determining the business year in which the corona support actually occurred.

The following is a brief and non-exhaustive overview of affected balance sheet items:

Key figure systems are often used for balance sheet evaluation – without these key figure systems a well-founded analysis of balance sheets can hardly be achieved. As already discussed above, the corona pandemic and the measures taken to reduce infection have particularly affected turnover. Many evaluation systems, however, use key figures that relate to the turnover. Examples include:

• Cash-flow rate = operating cash-flow / turnover
• Operating profit margin= (Earning from normal business activities + interest expenses) / turnover
• EBIT ratio= EBIT / turnover
• Gross margin ratio= (turnover + other operating income - material costs) / turnover
• Total asset turnover ratio = turnover / total assets

A meaningful analysis of a company's creditworthiness based on an isolated analysis of such balance sheets seems impossible and is unlikely to produce reliable results. So how should analysts estimate a company's ability to pay on the basis of financial reports from the business year 2020?

It can be stated that the distortions caused by corona make it necessary to take a more intensive look at the financial statements in order to be able to assess the individual financial situation and the crisis management of companies. Closer and more immediate checks, for example using inter-yearly financial reports, are recommended in order to be able to react to changes at short notice and thereby avoid economic losses.

Automation is indispensable

But who should perform all these time-intensive analyses? A (partially) automated analysis using balance sheet analysis software that can be introduced at short notice saves time for the analysis team, thus freeing up capacity that can be used for evaluating relevant customers and suppliers in detail. Such balance sheet analysis software often also serves as an early-warning system and informs you about conspicuous changes in company scores.

Ideally, the balance sheet analysis software also provides support in performing comparisons. In particular, time and company comparisons are an effective way of assessing company performance and creditworthiness, even in times of uncertainty. Time comparisons provide information as to whether, and to what extent, the figures for companies have changed over time. Company comparisons enable you to see how the company has mastered the crisis in comparison with other companies. Equipped with such a tool, reliable and transparent balance sheet and company valuations can be performed using the annual financial reports from the business year 2020.