Understanding Financial Statements and Their Role in Borrowing and Selling

Accurate and timely financial statements are critical to all aspects of business, from day-to-day operations to informing major decisions. Yet even the most thorough financial documents are of little benefit if you don’t understand how to read and interpret them.

Basic Financial Documents

Think of your Financial Statements as a report card that reflects how your business is performing financially. The essential documents include the following:

  • Balance Sheet
    • A “snapshot in time” of the current financial status of your business
    • Also referred to as Statement of Financial Position
  • Income Statement
    • A “moving picture” of what has occurred financially in your business over a specific period of time
    • Also referred to as Profit & Loss Statement (P&L)
  • Statement of Cash Flow
    • Provides aggregate data regarding all cash inflows and outflows from its ongoing operations and external investments.
    • It is often excluded from financial statements of small, closely held businesses but is a valuable tool for planning cash flow, driven by comprehensive financial modeling, for businesses of any size.

Sharing Financial Statements to Secure Credit

If and when you need to borrow, having the right financial documentation for your lender, and being able to discuss it, will weigh in your favor. Your bank or other lending institution will be interested in the following information:

  • How much equity you hold in the company
  • What collateral you can provide
  • Whether you have a history of available cash to repay the loan

Your financial ratios will provide this information. Income tax records may likely be requested by the lender to establish that financial statement activity is accurately reflected in the tax returns.

Sharing Financial Statements with a Potential Buyer

If you plan to sell your business upon your exit, or for any other reason, your prospective buyer will review and dissect your financial statements as part of his or her due diligence process. They’ll want the assurance that the business can generate adequate cash flow to return the purchase price over a specific period of time, typically dictated by the buyer’s preset criteria for the industry in which you operate. Combing through financial statements may also reveal opportunities to cut expenses. As with a lender, the buyer will request your income tax records, to reconcile financial statement activity to the entity tax return.

When the Buck Stops With You

As a business owner, you are not likely the individual in your organization who is primarily responsible for finance and accounting. But since the buck eventually stops with you, a thorough understanding of financial statements is essential. I’d welcome the opportunity to review your financial processes and help you gain the certainty that your financial statements are thorough, accurate, timely – and that you are able to use the data they produce to optimize the success of your company.

Contact me to schedule a complimentary consultation. Also ask me about our Exit Planning Peer Advisory Board – a great way to build your business and your future.

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