A company’s operations are financed by its equity. Equity consists of several elements, and both its size and composition provide important information on the financial position of the business. Changes to equity require continuous control by shareholders along with action where necessary.
Registered capital, a basic element of equity
Looking at the equity components, registered capital (share capital) is one of the basic elements for financing operations. If this has not been paid, it is recognised in a separate row of the balance sheet: registered capital not yet paid.
The mandatory minimum amount of registered capital is regulated by law for certain business types, while the expected size of other capital elements also has to be taken into account when it is determined. Act V of 2013 on the Hungarian Civil Code includes important requirements regarding the measures that are necessary in the case of limited liability companies when equity falls compared to the registered capital. Accordingly, a managing director must convene the members’ meeting without delay to take the necessary measures if it comes to his/her knowledge that:
- the company’s equity has fallen to half of the share capital due to a loss;
- the company’s equity has fallen below the statutory minimum amount of share capital;
- insolvency is looming over the company or it has stopped making payments;
- or the company’s assets do not cover its debts.
In these cases the members have to make a decision on making supplementary contributions, providing equity totalling the amount of share capital in another way, or decreasing the share capital. For lack of all these, a decision must be made to transform, merge or separate the company, or terminate it without a legal successor. The relevant resolutions of the members’ meeting must be carried out within three months. If this does not happen the share capital has to be decreased.
If capital falls, the amount of any supplementary capital contribution must be recognised as an increase in the allocated reserve. Supplementary contributions are regulated in the articles of association. Supplementary contributions that are not necessary to make up for the loss have to be repaid to the members on the list of members as of the date of repayment.
Shareholders can decide to settle the capital situation by increasing the capital reserve too; in this case the registered capital has to be increased, and the Court of Registration registers the amount based on the relevant members’ resolution. The amount put into the capital reserve can later be reduced by means of a capital decrease or rearrangement, and in the case of a capital decrease it must be ensured that all capital elements fall proportionally. The amount of the capital reserve can be transferred to offset any negative retained earnings if required.
In terms of the additional equity components, retained earnings show the accumulated earnings of previous years, which, provided equity is at an appropriate level and other conditions are also fulfilled, can be distributed as a dividend and used to increase registered capital.
The valuation reserve includes the valuation difference of assets at market value (valuation reserve for upwards revaluations) and the fair value reserve. Having such a reserve always needs contribution from an audit firm.
Profit after tax
Equity includes the profit after tax of the business for the reporting year, which, if the necessary conditions are met, can be distributed as a dividend to shareholders.
It is best to define the method for financing operations along with the elements and the amounts of equity when establishing the business, and to modify these during operations in light of the options allowed by Hungarian law. Taking appropriate measures ensures an optimal composition of equity, which will comply with statutory regulations, shareholders’ interests and provide protection for lenders. Should you need an expert for planning purposes, just contact the accounting consultants of WTS Klient Hungary.