Annual Report

What is an annual report?

Annual report (German: Geschäftsbericht) refers to the document with which a company reports on a past financial year. It combines the documents required by law with voluntary information on strategy, markets, key figures and organisation into one overall document. The mandatory parts are above all the annual financial statements, consisting of balance sheet, income statement and notes, as well as the management report (Lagebericht). In the latter, the management explains the course of business, the position and the outlook of the company.

Under current German commercial law, the annual report is not a legal term of its own. Only its mandatory components are regulated by law: the annual financial statements under the German Commercial Code (Handelsgesetzbuch, HGB), the management report and, for audited companies, the auditor's opinion (Bestätigungsvermerk), that is, the opinion arising from auditing. Listed companies publish their annual report regularly and address it to shareholders, analysts and the public. Unlisted companies prepare it voluntarily, mostly for shareholders, banks and important business partners. In funding rounds and company sales, the reports of earlier years serve as evidence of how reliably a management plans and reports.

Components of an annual report

Mandatory parts

• Annual financial statements: balance sheet, income statement and, for corporations (Kapitalgesellschaften), the notes. Capital-market-oriented companies add a cash flow statement and a statement of changes in equity.
• Management report: mandatory for medium-sized and large corporations. It presents the course of business and the position and assesses the expected development with its main opportunities and risks.
• Auditor's opinion: the opinion of the auditor, where a statutory or voluntary audit has taken place.
• Consolidated financial statements and group management report: for parent companies that are required to prepare consolidated accounts. An annual report on this basis is called a consolidated annual report or group annual report. It shows parent and subsidiary companies as if they were a single company.

Voluntary parts

Common are a letter from the management, a key figures overview covering several years, a presentation of business model, products and markets, and information on employees and organisation. Information on sustainability is increasingly included as well. Voluntary parts are subject to no statutory structure and, as a rule, no audit. The standard nevertheless applies that they must agree with the audited figures; deviations are immediately noticed by an attentive reader.

Additional parts for listed companies

Issuers whose securities are admitted to a regulated market, that is, to the statutorily regulated stock exchange trading, publish an annual financial report under the German Securities Trading Act (Wertpapierhandelsgesetz). The deadline is four months after the end of the financial year. The report contains the audited financial statements, the management report and the statement by the legal representatives that both give a true and fair view (Bilanzeid, balance sheet oath). For a listed stock corporation (Aktiengesellschaft), the report of the supervisory board, the corporate governance statement and the remuneration report are added.

The management report in the annual report

While the annual financial statements depict what has happened, the management report explains why it happened and what the management expects. Under Section 289 of the German Commercial Code (HGB), it analyses the course of business using the most important financial key figures. It assesses the expected development and presents the main opportunities and risks. The underlying assumptions must be stated. Large corporations also include non-financial performance indicators, for example information on environmental and employee matters.

The forecast section is the part by which a management has to be measured in the following year. Readers compare the announced development with the actual result. For the group management report, German Accounting Standard No. 20 (Deutscher Rechnungslegungs Standard Nr. 20, DRS 20) specifies the requirements. In practice, it also serves as a benchmark for the management report of single-entity financial statements. Under it, forecasts are formulated with the direction and extent of the expected change, often as a range.

Sustainability reporting

Certain large capital-market-oriented companies have for years reported on non-financial matters such as the environment, employees, human rights and anti-corruption measures. The European Corporate Sustainability Reporting Directive (CSRD) is intended to widen the circle of companies subject to reporting. It prescribes uniform reporting standards and moves the disclosures into the management report. Scope and timing have been amended several times at European level. The current state of transposition into German law applies.

Irrespective of an obligation of their own, smaller companies are also asked for sustainability data. The questions come, for example, from large customers subject to reporting, from banks when granting loans and from funds that must themselves report on their holdings. In due diligence, the question about these data is therefore increasingly standard.

How investors and buyers read annual reports

Experienced readers seldom begin with the management's letter. In due diligence, the first interest is in the information in the notes on contingent liabilities, other financial commitments and off-balance-sheet transactions. These include, for example, guarantees, long-term rental and leasing contracts or purchase commitments. Next comes the risk report of the management report. Both show burdens that do not yet appear in the balance sheet, or only partly.

Read over several years, annual reports provide a time series of forecasts and actual results. Investors use it to assess planning quality before they follow the company's current financial model. Buyers compare the equity story of a sale process, that is, the presentation of business model and growth prospects, with what the management itself reported in previous years. Contradictions between the two regularly lead to more detailed questions.

Practical example: annual report of a software GmbH

A software provider in the legal form of a GmbH (German limited liability company) has employed on average around 70 people for two years. Its balance sheet total is around EUR 9 million in both years. It thus exceeds two thresholds of the small corporation on two consecutive reporting dates and is medium-sized, so its financial statements are subject to audit. Shareholders are the founders, several private investors (business angels) and two venture capital funds. Besides the published annual financial statements, the management prepares an annual report of around 20 pages each year for shareholders, house bank and managers. It is structured as follows:

• a one-page letter from the management with the most important developments and decisions of the year
• a key figures overview over three years with recurring revenue, gross margin, customer churn, employees and cash and cash equivalents, each with a constant definition
• a comparison of forecast and result: revenue of EUR 9 to 10 million had been announced, and EUR 8.6 million was achieved. That is EUR 0.4 million or about 4% below the lower end, explained by the postponement of two large orders to the following year
• the management report with a forecast as a range and specifically named risks
• the audited annual financial statements with the auditor's opinion

When the company prepares a funding round two years later, the reports of three years are in the data room. The investors can verify the quality of the forecasts themselves and do not have to reconstruct the key figure history from individual documents first.

Distinctions: management report, annual financial report and investor update

• Management report: report of the management required by law on the course of business, position, opportunities and risks. For medium-sized and large companies it is a mandatory part of the annual report, not a synonym for it.
• Annual financial report: publication required under capital market law of listed issuers with a fixed minimum content. The annual report is often its designed version.
• Investor update: regular report to the shareholders, usually monthly or quarterly. It is more current, but unaudited and not public.

Common mistakes

• Generic risk reports. A risk report without specifically named risks and without an assessment of their significance is read as a lack of self-assessment, not as a strength.
• Forecast as a point value. A single figure without assumptions can hardly be achieved and is read as a miss in the following year. A reasoned range is more robust.
• Changing key figure definitions. If a key figure is defined differently every year, the multi-year comparison is worthless, although it is the actual purpose of the overview.
• Passing over missed forecasts. A deviation that is not explained in the following report is noticed by investors anyway and then weighs more heavily.
• Design before content. An elaborately designed report with few reliable statements arouses doubt rather than convincing.

Frequently asked questions

What is the difference between an annual report and annual financial statements?

The annual financial statements are the set of figures required by law, consisting of balance sheet, income statement and notes. The annual report is the more comprehensive document: it contains annual financial statements and management report and supplements them with voluntary parts such as the management's letter or a key figures overview.

Does a GmbH have to prepare an annual report?

No. What is mandatory are the annual financial statements, for medium-sized and large companies the management report, and disclosure. A designed overall document is voluntary for unlisted companies.

Is the annual report of a GmbH published?

Only to the extent the company wishes. In the company register (Unternehmensregister), the documents that must be disclosed by law appear to the extent prescribed by the size class. Voluntary parts remain internal as long as the company does not publish them itself.

Who audits the voluntary parts?

As a rule, nobody. The auditor audits the annual financial statements and the management report. Other information in the annual report is read critically for material inconsistencies with the financial statements, without being audited or confirmed.

Is an annual report worthwhile for a company ahead of a funding round?

Often yes, if it stays concise. An annual report of 15 to 25 pages for shareholders and bank creates a documented key figure history on which a later funding round can draw. An elaborate brochure is not required for this.

How long is the forecast period in the management report?

At least one year, counted from the reporting date. That is what DRS 20 provides, which also serves as a benchmark for the management report of a GmbH. Longer periods are permissible but are mostly presented only descriptively.

The Roemer Capital view

To prepare a funding round or a sale, Roemer Capital lays the management reports and annual reports of the last three years side by side. Each forecast is compared with the actual result. Because investors and buyers carry out exactly this comparison, Roemer Capital explains deviations before they are asked about.

For the future, Roemer Capital advises forecasts that agree with the financial model: the same key figures, the same definitions, a range between cautious case and base case. What is stated in the management report must be capable of being substantiated with the figures in the next process.