Balance Sheet

What is a balance sheet?

Balance sheet (German Bilanz) refers to the comparison of a company's assets and capital at a specific reporting date. The asset side (assets, in German Aktiva) shows which assets exist; the liabilities and equity side (Passiva) shows how they are financed: by the shareholders' equity or by debts owed to third parties. Both sides always add up to the same amount, the balance sheet total. It describes the size of a company, not its value. A household's overview of its assets is comparable: on the left the flat, the car and the bank balance, on the right the loans and, as the remainder, what the household itself owns, that is, its equity.

Together with the income statement (Gewinn- und Verlustrechnung, GuV), the balance sheet forms the core of the annual financial statements under the German Commercial Code. The duty to prepare a balance sheet arises from the German Commercial Code (Handelsgesetzbuch, HGB): merchants prepare a balance sheet at the start of their trade and at the close of each financial year (Section 242(1) HGB). Only small sole traders are exempt (Section 241a HGB). The GmbH (German limited liability company) always counts as a commercial company and must therefore always prepare a balance sheet. In addition, the balance sheet serves as a monthly interim balance sheet in investor reporting and as the basis for calculating the purchase price in a company acquisition.

Balance sheet under the HGB: reporting date, deadlines and disclosure

The reporting date is the close of the financial year, usually 31 December; a financial year may not exceed twelve months (Section 240(2) HGB). For a corporation, the management prepares the annual financial statements within three months after the reporting date. A small corporation has up to six months, provided this corresponds to proper business practice (Section 264(1) HGB).

The shareholders then resolve on adoption (Feststellung), that is, the binding approval of the financial statements, and on the appropriation of the result. The German Limited Liability Companies Act (GmbH-Gesetz, GmbHG) sets eight months for this, or eleven months for small companies (Section 42a(2) GmbHG). How much has to be disclosed and whether an auditor audits the financial statements depends on the size class under Section 267 HGB. It is determined by balance sheet total, revenue and number of employees; the thresholds were raised in 2024. Medium-sized and large corporations are subject to mandatory audit (Section 316 HGB).

Structure of the balance sheet under Section 266 HGB

Corporations prepare the balance sheet in account form (Section 266(1) HGB), that is, with two opposite sides: assets on the left, liabilities and equity on the right. The asset side is ordered by the length of time capital is tied up, from assets tied up for the long term to liquid funds. The liabilities and equity side follows the maturity of the funds, from equity provided permanently to liabilities. The overview shows the main items and their most important groups. Medium-sized and large companies break the items down further, small ones may omit this, and micro-entity corporations (Kleinstkapitalgesellschaften) show only the main items (Section 266(1) HGB):

• Assets (Aktiva): fixed assets (intangible assets, tangible assets, financial assets), current assets, prepaid expenses (aktive Rechnungsabgrenzungsposten), deferred tax assets and any surplus of plan assets over pension liabilities (aktiver Unterschiedsbetrag aus der Vermögensverrechnung).
• Liabilities and equity (Passiva): equity (subscribed capital, capital reserve, retained earnings, profit or loss carried forward, net income or net loss for the year), provisions, liabilities, deferred income (passive Rechnungsabgrenzungsposten) and deferred tax liabilities.

Prepaid expenses and deferred income assign payments to the financial year to which they economically belong, such as insurance paid in December for the following year. Deferred taxes reflect future tax burdens or tax relief that arise because the commercial balance sheet and the tax balance sheet recognise individual items differently. If the annual result is already partly appropriated when the statements are prepared, for example for retained earnings, the item balance sheet profit or balance sheet loss replaces the annual result and the profit or loss carried forward (Section 268(1) HGB).

Two special rules frequently concern growth companies. If equity has been completely used up by losses, the excess amount appears at the end of the asset side as a "deficit not covered by equity" (Section 268(3) HGB). The second concerns shareholders: loans, receivables and liabilities in relation to them must, in the case of a GmbH, generally be shown separately or disclosed in the notes (Section 42(3) GmbHG). A shareholder loan thereby becomes visible but remains debt capital in the commercial balance sheet.

Informative value and limits of the balance sheet

The equity ratio relates equity to the balance sheet total and shows which losses the company can absorb before creditors are affected. Fixed asset coverage tests whether assets tied up for the long term are also financed for the long term (golden balance sheet rule).

The commercial balance sheet serves creditor protection and follows the prudence principle: assets are in principle recognised at no more than their acquisition or production cost, and higher market values remain invisible as hidden reserves. Self-created brands and customer lists may not be capitalised (Section 248(2) sentence 2 HGB); the value of technology and team appears at most to the extent of capitalised development costs. How the individual valuations arise is governed by financial accounting. Because the balance sheet depicts only a single day, it becomes informative only when several reporting dates are compared and when it is read together with the income statement, cash flow statement and liquidity plan.

The balance sheet in a funding round and a company acquisition

In a funding round, investors check three points in the balance sheet. First, which financing instruments already exist, such as convertible loans (loans that can later be converted into shares) or shareholder loans. Second, whether the capital reserve (payments by earlier investors above the nominal amount of the shares) fits the investment agreements. Third, how quickly losses consume the equity. The last question has a legal side. If a balance sheet shows that half of the share capital has been lost, the management must convene the shareholders' meeting without delay (Section 49(3) GmbHG). Share capital (Stammkapital) is the nominal amount of capital fixed in the articles of association; for a GmbH, it is at least EUR 25,000.

In a company acquisition, the balance sheet is at the centre of the financial due diligence, the buyer side's examination of the financial figures before the contract is signed. From several reporting-date balance sheets, the buyer derives three figures that determine the purchase price for the shares. Net debt comprises financial debt less freely available liquid funds. Debt-like items are obligations such as pension commitments or back taxes. Working capital is the capital tied up in the ongoing business.

With the locked box mechanism, the purchase price is fixed on a reporting-date balance sheet that already exists; with a purchase price adjustment based on a closing-date statement (completion accounts), it is fixed on a balance sheet as of closing. The seller regularly gives a balance sheet warranty, that is, the assurance that the financial statements comply with the statutory rules.

Worked example: analysing the balance sheet of a software GmbH

A young software company, a GmbH with share capital of EUR 40,000, reports the following simplified balance sheet as of 31 December:

• Fixed assets (acquired software, operating and office equipment): EUR 200,000
• Receivables and other assets: EUR 500,000
• Cash at banks: EUR 1,500,000
• Prepaid expenses: EUR 50,000
• Balance sheet total of assets: 200,000 + 500,000 + 1,500,000 + 50,000 = EUR 2,250,000
• Equity: subscribed capital EUR 40,000 plus capital reserve EUR 7,160,000 minus loss carried forward EUR 5,400,000 minus net loss for the year EUR 1,300,000 = EUR 500,000
• Provisions: EUR 150,000
• Liabilities: convertible loan from the shareholders EUR 600,000, suppliers EUR 200,000, other EUR 100,000, together EUR 900,000
• Deferred income from annual licences paid in advance: EUR 700,000
• Balance sheet total of liabilities and equity: 500,000 + 150,000 + 900,000 + 700,000 = EUR 2,250,000

The analysis from an investor's point of view:

• Equity ratio: 500,000 / 2,250,000 = 22.2%
• Capital consumption: Of EUR 7,200,000 in paid-in capital (40,000 + 7,160,000), losses of EUR 6,700,000 (5,400,000 + 1,300,000) have used up around 93%.
• Distance to the loss notification: The threshold of Section 49(3) GmbHG is at half of the share capital, that is, EUR 20,000. With a monthly loss of around EUR 108,000 (1,300,000 / 12), the distance of EUR 480,000 is used up in less than five months.
• Prefinancing by customers: Of EUR 1,500,000 in bank balances, EUR 700,000 are matched by services that have already been paid for but are still to be delivered.
• Effect of a conversion: If the convertible loan is converted, equity rises to EUR 1,100,000 and the equity ratio to 1,100,000 / 2,250,000 = 48.9%.
• Net debt without conversion: 600,000 minus 1,500,000 = minus EUR 900,000, that is, net financial assets of EUR 900,000

The bank balance alone therefore says little: the liquid funds are to a considerable extent prefinanced by customers, and with an unchanged loss rate the equity lasts only a few more months. A conversion of the loan before the next round would extend the distance to the threshold of Section 49(3) GmbHG by a good five and a half months (600,000 / 108,000 = 5.6 months).

Distinction: balance sheet, annual financial statements, tax balance sheet, over-indebtedness statement

• Annual financial statements: comprise the balance sheet and income statement and, for corporations, additionally the notes. A management report stands alongside and is not part of them.
• Tax balance sheet: is derived from the commercial balance sheet and deviates where tax accounting law prescribes its own recognition or valuation rules; it is set out above all in Sections 4 to 7 of the German Income Tax Act (Einkommensteuergesetz, EStG). Smaller companies often prepare a unified balance sheet (Einheitsbilanz) that serves both purposes.
• Over-indebtedness statement: a special statement for the test under Section 19 of the German Insolvency Code (Insolvenzordnung, InsO) with its own recognition and valuation rules. Negative equity in the commercial balance sheet therefore does not necessarily mean over-indebtedness in the insolvency law sense.

Common mistakes

• Reading the bank balance without the liabilities and equity side. Liquid funds that are matched by customer prepayments, short-term loans or taxes falling due are only partly freely available.
• Balance sheet only at year-end. Without a monthly interim balance sheet, the management may notice the consumption of equity only when the duty to convene under Section 49(3) GmbHG arose long ago.
• Presenting shareholder loans as equity. In their analysis, investors reclassify such loans as debt capital and afterwards also question the other figures.
• Reading the book value as the company value. The company value results from future surpluses; low or even negative equity does not rule out a high valuation.

Frequently asked questions

What is the difference between a balance sheet and an income statement?

The balance sheet is a statement of stocks at a reporting date; the income statement is a statement of performance for a period. The two are linked through equity: a net income for the year increases it, a net loss for the year reduces it.

Must a GmbH publish its balance sheet?

Yes. Every corporation must file its annual financial statements with the German Company Register (Unternehmensregister), where they can be viewed publicly, at the latest twelve months after the reporting date (Section 325 HGB). For small companies, the balance sheet and notes without the income statement are sufficient; micro-entity corporations can deposit the balance sheet so that it is transmitted to third parties only on request. If the deadline is missed, the Federal Office of Justice (Bundesamt für Justiz) initiates an administrative fine procedure.

Who prepares the balance sheet of a GmbH, and who adopts it?

The management prepares and signs the annual financial statements; they are often drawn up by the tax adviser. They become binding only through the adoption resolution of the shareholders' meeting (Section 46 no. 1 GmbHG).

Which balance sheets belong in the data room?

Customary are the adopted annual financial statements of the last two to three financial years, where applicable with the audit report, plus a current interim balance sheet with the trial balance (Summen- und Saldenliste), the overview of all accounts in the bookkeeping. In a company sale, monthly balance sheets for the period from which normalised working capital is derived are added.

The Roemer Capital view

Before a company speaks with investors, we read its balance sheet the way the other side will. First comes the liabilities and equity side with convertible loans, shareholder loans and prepaid customer contracts, then the question of how many months the remaining equity lasts at the current loss rate. We discuss any need for action, such as a conversion before the round, with the management and the tax adviser before documents go to investors.

Where we take on the finance function for a limited period (fractional CFO), we set up monthly reporting in which the balance sheet, income statement and liquidity plan are available together. This means the data room can be made available within 24 hours, and no development in the balance sheet comes to an investor's attention before the management's.