Question: What are the most important financial statements for small business owners to understand, and why?
Answer: A business owner must know and understand the balance sheet, income statement and cash flow statement as all of these statements are important to demonstrating the health of the business.
The balance sheet shows the company’s assets, liabilities and net worth at a point in time, and it discloses information that will play an important role in a banker’s decision to provide financing. Three things the banker will look at in the balance sheet are liquidity, leverage and net worth.
Liquidity is the ability of a business to meet its short term obligations, and is measured by the company’s quick and current ratios and working capital position. It is essential that a business be able to show that it can convert assets into cash relatively fast to keep current operations going. Leverage and net worth are a measurement of the company’s ability to sustain business activities over a long period of time. If a company is highly leveraged, and has a limited net worth position, its chances of surviving over the long run are not good, especially if there is an interruption in demand or an increase in expenses that negatively impact profitability.
The income statement, also known as a profit and loss statement, discloses a business’ revenue, expenses and profit or loss for a period of time. It will be important for the business owner to show that he or she can generate a profit. A company that does not make money will not be in business long and will drain the resources of the business owner until it is no longer a going concern.
The cash flow statement shows the amount of cash that is expected to come in and out of the business. This statement can tell the business owner how much capital he or she will need run their business. It can also tell them if they have excess cash or if there expenses are too high. This is important because it shows whether or not the business can generate enough cash flow to pay back debt.
If you have any additional questions about the financial statements necessary to secure small business financing, feel free to reach out to one of our business bankers.