Crafting Impactful Management Reports: Essential for Estonian Companies at Fiscal Close

For a large part of Estonian companies, the deadline for submitting annual report is June 30. Although the bulk of this work is done by the accountants, the preparation of the report also requires input from the company's management, especially for the management report. What is it and why is it important to pay attention to it?

The management report provides external parties interested in the company with a primary and quick overview of the company's activities, results, and other significant events of the past year, as well as future plans. Therefore, it is crucial that the management report is sufficiently comprehensive and informative. The minimum content of the management report is regulated by the Accounting Act, but more information can always be disclosed to provide a better, clearer, and more comprehensive picture of the company.
Section 24 of the Accounting Act outlines the minimum requirements that must be described in the activity report.

The management must give an overview of the company's operations, significant events, and development directions.
Information about branches located in foreign countries must be disclosed.
The company's main areas of activity and groups of products and services must be described.
Significant investments, as well as research and development projects undertaken during the fiscal year or planned for the coming years, must be described. Here, the nature of the projects should be described, and the expenditures made and planned should also be disclosed.
Events that were not reflected in the annual accounts but may significantly affect the results of the following years should be highlighted. For example, potential impacts of global pandemics, armed conflicts and similar occurrences on the company's operations and results can be mentioned.
If the company's net assets at the end of the year do not meet the requirements of the Commercial Code, it must be described what is planned to restore the net assets. There is a more detailed discussion about the company's net assets and its requirements below.
If the company has purchased or taken its own shares as collateral, information related to these transactions must also be disclosed, including the nominal value of the shares, the fee paid for them, and the reason why such a transaction was performed.

One important requirement, generally checked by the Business Register, is the compliance of a company's equity, or net assets, with the Commercial Code. A company's net assets represent all assets that would belong to the owners upon cessation of the company's operations, i.e., what remains after all obligations are paid. This includes, for example, share capital, share premium, reserves formed, and undistributed profit. According to the Commercial Code, a company's net assets must be at least half of the share capital, and the articles of association may prescribe even stricter limits. Net assets may fall below the requirements of the Commercial Code primarily when a company is unprofitable and does not have sufficient undistributed profits from previous years to cover the loss. If net assets have fallen below the limits set by the Commercial Code, the management report must describe what the company plans to do to restore the net assets. For example, the company's owners may decide to increase the share capital or make other additional contributions. It is also possible that the loss incurred was one-time or temporary and the results of the current fiscal year are positive, which allows covering the previous year's loss with the new year's profit. For more detailed information on minimum net asset requirements and equity restoration options, you can contact the specialists from BDO.

If a company's volumes of activity are sufficiently large and an audit or review of the annual report is required, there are additional requirements for the management report.

In addition to the minimum requirements previously mentioned, the company must describe the general macroeconomic development of its operating environment and its impact on its profit statement.
The company must also describe the seasonality or cyclicality of its business activities and significant social and environmental impacts associated with its operations.
An overview must be provided of how the company mitigates financial risks associated with its receivables, liabilities, and investments, and describe the risks that have emerged related to changes in exchange rates, interest rates, and stock market prices. It is also important to note that significant information must be disclosed for both the concluded fiscal year and the current period, in case significant risks have emerged after the end of the fiscal year.
Key financial ratios and their calculation formulas for at least the last two fiscal years must be presented. Some examples of the main financial ratios are provided below.

When using ratios, it's essential to consider the specific nature of a company's operations, as there are no universal ratios. Ratios must be relevant to the company's operations and make the report comparable with other similar companies in the same industry. Here are some examples of commonly disclosed ratios in management reports:

Financial ration	Description	Example formula
Revenue growth rate	Shows how much sales revenue has changed compared to the previous period	Δ Revenue / Revenue of previous period * 100%
Gross margin	Shows how much gross profit was earned as a percentage of each euro of sales revenue	Gross profit / Revenue * 100%
EBITDA margin	Shows the company's profitability, excluding the effects of income tax, financing decisions, and capital investments	EBITDA / Revenue * 100%
Net profit margin	Shows how much net profit was earned as a percentage of each euro of sales revenue	Net profit / Revenue * 100%
Profit growth rate	Shows how much and in which direction the company's profit has changed	Δ Net profit / Net profit of previous period * 100%
Current ratio	Shows how much current assets the company must cover its short-term obligations	Current assets / Current liabilities
Acid test, Quick ratio	Shows how much liquid assets are available to cover short-term obligations	(Current assets - Inventories) / Current liabilities
Cash ratio	Shows how prepared the company is to immediately settle its short-term obligations	(Cash + Cash equivalents) / Current liabilities
ROA	Shows how efficiently the company uses its assets	Net profit / Total assets * 100%
ROE	Shows how much profit the money invested by the owners generates	Net profit / Shareholder’s equity * 100%

Additional requirements have been imposed on large public interest entities with more than 500 employees. Detailed requirements have also been established for issuers of securities traded on the stock exchange.

In addition to the aforementioned, the management report may also describe other important matters, such as sustainability-related topics. It is important that the management report provides the reader with a concise and comprehensive overview of the company's activities in the past period and its future plans. If you need assistance with preparing the management report, feel free to contact the specialists at BDO in Estonia.