The paper presents the importance of financial statements in determining the insolvency of a company. The first part of the article presents a case study and the main signals of bankruptcy: negative working capital, negative equity capitals, losses, etc. In the end of the paper we detail issues that are not observable and that are related to the actual management of the company.working capital, working capital need, treasury, equity capitals, annual financial statements

Hada Teodor

English

Research Papers in Economics

559 
 
ANNUAL FINANCIAL STATEMENTS – A SOURCE FOR THE FINANCIAL 
DECISIONS OF INSOLVENT COMPANIES  
Hada Tedor 
 "1 Decembrie 1918" University, Alba Iulia, Romania 
 Faculty of Science  
 
The paper presents the importance of financial statements in determining the insolvency of a 
company. The first part of the article presents a case study and the main signals of bankruptcy: 
negative working capital, negative equity capitals, losses, etc. In the end of the paper we detail 
issues that are not observable and that are related to the actual management of the company.   
 
Key words: working capital, working capital need, treasury, equity capitals, annual financial 
statements  
 
JEL classification: G33 
 
In Romania, the structure of annual financial statements was regulated by OMFP no. 94/2000 and 
306/2000, then by OMFP no. 1752/2005 and recently by OMFP no. 3055/2009 and includes: 
-  the balance sheet; 
-  the short balance; 
-  the profit and loss account; 
-  the statement of changes in equity capital; 
-  the statement of cash flows; 
-  Notes. 
Economically, it is useful for the economic agents to determine those indicators that can prevent 
insolvency based on the analysis of the data in the annual financial statements. The specialized 
literature presents for this purpose models like: the Z score recommended by E. Altman, the 
Canon Holder model, the model of William Beaver, the model of the Central Bank of France and 
the Cematt model. More recently, commercial banks have bankruptcy risk assessment methods, 
such  as:  the  method  of  the  Romanian  Commercial  Bank,  the  method  of  the  Romanian 
Development Bank – Groupe Societe Generale, the method of Transilvania Bank, the method of 
Raiffeisen Bank, which are methods tailored for Romanian economy, with obvious results in the 
diagnosis of bankruptcy.    
Although the causes that determine bankruptcy are varied, we believe that some have decisive 
influences in this regard, such as:  
-  the lack of order contracts after 1990;  
-  outdated technology; 
-  inadequate legislation for privatization;  
-  persistence of strikes; 
-  low productivity; 
-  property claims; 
-  inadequate price policies; 
-  Stock production; etc. 
Steve Robinson in the book “Financial Management”
370 shows the easily identifiable problems 
based on annual financial statements, such as:  
-  the massive increase of the credit account (debts);  
                                                       
370 Steve Robinson, Financial Management, Teora Publishing, Bucharest, 2005, p. 147 560 
 
-  the substantial increase in stock (inventory); 
-  reduction in liquidity; 
-  increasing the amounts borrowed; 
-  cutting back on future investments; 
-  Reduction in paid dividends. 
Next, we will present the balance sheet structure of an economic agent
371 for two consecutive 
reporting periods. Therefore:   
-lei- 
The debit structure  N  N+1 
Total fixed assets, of which:  365408,0  238526,5 
-  intangible assets  -  - 
-  tangible assets, of which:  365310,0  238428,5 
-  freehold land  105451,2  - 
-  buildings  248743,0  235212,8 
-  plant and machinery  4998,2  2591,0 
-  motor vehicles  4109,7  624,7 
-  other fixed assets  -  - 
-  tangible assets in progress  2007,9  - 
-  financial assets  -98,0  -98,0 
Total current assets, of which:  52289,2  33929,7 
       Inventory:  11638,7   
-  raw materials  5744,7   
-  semi-finished goods  5004,6   
-  goods purchased for resale  35,0   
-  packaging materials  854,4   
Other current assets, of which:  40650,5  33929,7 
-  clients and similar accounts  38182,4  33741,7 
-  other claims  1829,2  - 
-  investment papers  100,0  100,0 
-  bank accounts  7,2  13,0 
-  petty cash in lei  531,7  74,1 
-  other values  -  0,9 
Suspense account  13699,2  - 
TOTAL ASSET  431396,4  272456,2 
  lei 
The credit structure   N  N+1 
Equity capitals, of which:   -208005,6  -1030585,5 
-  social capital  733701,2  595000,0 
-  uncovered loss  -  -939968,3 
-  loss  -943123,8  -685617,2 
-  other funds  1417,0  - 
Long-term loans  147526,4  181565,7 
Suppliers and similar accounts  43627,3  28047,7 
Creditor clients  2289,2  1155,0 
                                                       
371 Data are real 561 
 
Other debts  445959,1  1092273,3 
TOTAL LIABILITIES  431396,4  272456,2 
 
Based on the comparative data of the two consecutive balances, the following can be highlighted:  
-  regarding intangible assets, freehold lands in the year N+1 was missing because lands 
were retroceded to their owners;  
-  the inventory was exploited, so in the year N+1 the company had no stock;  
-  clients and similar accounts dropped from 40650,5 lei to 33929,7 lei; 
-  suspense accounts have not occurred in the year N+1;  
-  from -208005,6 lei  in the year N, equity capitals reached -1030585,5 lei, so the net 
asset is negative;  
-  long-term loans increased from 147526,4 lei to 181565,7 lei; 
-  unpaid supplied recorded a drop from 43627,3 lei to 28047,7 lei;  
-  other debts grew 2.5 times.  
By calculating the net working capital with the help of the two known methods, results:  
a) NWC = Permanent capital – Assets  
b) NWC = Assets – Short-term debts  
For the year N, we have: 
a) ￿￿￿￿ = -208005,6 + 147526,4 – 365408,0 = -425887,2 
b) ￿￿￿￿￿= 52289,2 + 13699,2 – (43627,3 + 2289,2 + 445959,1) = 65988,4 – 491875,6 =  
￿￿-425887,2 
For the year N+1, we have: 
a) ￿￿￿￿￿￿ = -1030585,5 + 181565,7 – 238526,5 = -1087546,3 
b) ￿￿￿￿￿￿ = 33929,7 – 1121476 = -1087546,3 
The working capital in the year N, as well as in the year N+1, is negative and represents a signal 
that the company is in difficulty, and the working capital, as the main financing source of the 
current assets, can’t finance these assets.   
Next, we’ll determine the company’s treasury in the two analyzed years. In order to do this, we’ll 
determine:  
The need for working capital = Stocks + Claims – Operating debts, and it will result:  
Year N: 11638,7 + 38182,4 + 1829,2 + 13699,2 – (43627,3 + 2289,2 + 445959,1) = 65349,5 – 
491875,6 = -426526,1  
Year N+1: WCNeed= 0 + 33741,7 – (28047,1 + 1155,0 + 1092273,3) = 33741,7 – 1121476 = 
 = -1087734,3 
The treasury has values in the two analyzed years:  
Treasury = NetWC –WCNeed  
Year N: T = -425887,2 + 426526,1 = 638,9 
Treasury = Availability – Treasury credits = 100 + 7,2 + 531,7 = 638,9 
Year N+1: T = -1087546,3 + 1087734,3 = 188,0 
     T = 100 + 13,0 +74,1 + 0,9 = 188,0 
The values of the treasury in year N, as well as in year N+1, are low. The companies used drawn-
in sources for financing, meaning delaying the payment of short-term debts.  
lei 
Indicator  Year N  Year N+1 
TOTAL operating revenue, of which:  -257463,7  125015,5 
-  revenues from sale of goods  8567,1  782,9 
-  sold production  423442,2  53479,6 
-  turnover  432009,3  54262,5 562 
 
-  stored production income  -689473,0  37503,0 
-  revenue from tangible assets production    33250 
Operating expenses, of which:  670195,9  531739,8 
-  goods for resale  7470,9  726,2 
-  total material expenses  182126,2  66415,9 
-  third party services expenses   13244,6  22600,7 
-  taxes, duties and similar expenses  5341,3  340564,8 
-  total personnel expenses  111175,5  88763,2 
-  other operating expenses  394776  - 
-  adjustment  expenses  for  fixed  assets 
(depreciation) 
311359,8  12669,0 
Operating loss:  927659,6  406724,3 
Total financial revenues, of which:  11,5  77264,4 
-  interest income  11,5  46,8 
-  other financial revenues  -  77217,6 
Financial expenses, of which:  73892,1  71740,5 
-  interest expenses  73892,1  48335,5 
-  other financial expenses    23405,0 
Financial profit    5523,9 
Financial loss  73880,6   
Extraordinary revenues  59436,6  12951,5 
Extraordinary expenses  1020,2  297368,3 
Extraordinary profit  58416,4  - 
Extraordinary loss    284416,8 
Total revenues  -198015,6  215231,4 
Total expenses  745108,2  900848,6 
Total loss  943123,8  685617,2 
 
By analyzing the data in the profit and loss account, the following will result:  
-  the operating revenues in the year N were negative due to the income from the stored 
production (debit balance);  
-  the operating revenues in the year N+1 were 125015,5 lei, being influenced by the 
revenues from the tangible asset production of 33250 lei; 
-  the operating expenses were higher than revenues in the two analyzed years;  
-  personnel  expenses  in  the  year  N+1  were  higher  than  the  turnover,  which  were 
economically unjustified;  
-  operating losses were recorded in both years;  
-  the financial activity recorded loss in the year N, but brought financial profit in the 
year N+1;   
-  the extraordinary activity brought profit in year N, and extraordinary loss in the year 
N+1.   
Overall, loss was achieved in both years.  
Mihaela Onofrei, in the book “Financial Management”
372 shows that “managers must 
identify early the signs of deteriorating financial statements of the enterprise, such as:  
                                                       
372 Mihaela Onofrei, Financial Management, C.H. Beck Publishing, 2006, p. 115 563 
 
-  achieving negative financial results;  
-  the existence of negative working capital;  
-  the inability to reimburse credits at maturity;  
-  the bankruptcy of suppliers and clients important for the enterprise;  
-  reduced availability or unavailability of a manager;  
-  the persistence of strikes.” 
Steve Robinson
373 shows that “they are problems difficult to identify”, so these “accounts do not 
reveal everything” and he goes on to mention the list of events that announce bankruptcy:  
-  accounting norms and practices – other than the ones that are standard – compared to 
the norms of the competition and with the norms existent in the concerned sector;  
-  fast increase of the sales volume, of the main accounts, of the working capital;  
-  the inability to reimburse credits at maturity; 
-  the inability to draw-up in time the financial reports and the account statements;  
-  combining the functions of the chairmen and chief executive, especially when these 
functions are associated with a large package of own shares;  
-  leading and charming personalities that are acting as managers of the company;  
-  frequent resignations from the managing board;  
-  sale of shares belonging to the company director (in the Financial Times magazine, 
for  the  companies  listed  in  the  UK),  especially  right  before  „closing”  (seven  weeks 
before announcing the financial results of the company); 
-  transition from asset acquisition to leasing;  
-  predatory behaviour of the management;  
-  unexplained transactions between the subsidiaries of a company.  
We  believe  that  since  the  company  recorded  negative  operating  revenues,  negative  working 
capital, losses and unjustified values in the year N, bankruptcy was imminent.   
 
References:   
1.  Hada, T. (2009), The Financial Management of the Enterprise, Aeternitas Publishing, Alba 
Iulia 
2.  Onofrei, M. (2006), Financial Management, C.H. Beck Publishing, Bucharest 
3.  Robinson, S. (2005), Financial Management, Teora Publishing, Bucharest 
4.  OMFP 3055/2009 for the approval of accounting regulations consistent with EU directives  
 
 
 
 
   
                                                       
373 Steve Robinson, Financial Management, Teora Publishing, Bucharest, 1999, p. 150 

Financial Management,

OMFP 3055/2009 for the approval of accounting regulations consistent with

The Financial Management of the Enterprise, Aeternitas Publishing,

ANNUAL FINANCIAL STATEMENTS - A SOURCE FOR THE FINANCIAL DSECISIONS OF INSOLVENT COMPANIES

http://anale.steconomiceuoradea.ro/volume/2010/n2/087.pdf

ANNUAL FINANCIAL STATEMENTS - A SOURCE FOR THE FINANCIAL DSECISIONS OF INSOLVENT COMPANIES

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