Whether a business needs capital today or in the future, business owners must understand what drives debt or equity providers to want to invest capital. While there are many available avenues for financing – traditional banking (including SBA loans), private debt, private investors, etc. – the basic requirements are surprisingly similar.
A good guide to the main areas any lender will focus on is the five C’s of credit – character, capacity, capital, collateral, and conditions. These address both qualitative and quantitative aspects of the business and its ownership. While the qualitative aspects (mainly character and conditions) are very important in lending decisions, the focus here is on the quantitative aspects of the lending decision, in particular the financial information to be presented. Simply presenting past bank statements or a cash-based income statement will not be enough to satisfy the requirements of lenders and will likely negatively impact their qualitative assessment of the company.
“The minimal investment required to get there is often much smaller than the returns that come to those with better financial reporting.”
To present the best quantitative data package and enhance the qualitative assessment of the business, the following financial statement information will demonstrate the current financial condition of the company, its cash flows and its ability to repay a loan or equity investment:
- Annual profit and Loss statement for the last three years
- Fiscal year-end balance sheet for the last three years, including detailed schedules for significant assets and liabilities
- Cash flow statements for the last three years
- Projected financial statements (including month to month cash flow estimates, for a minimum of one year)
But just presenting the information is not enough. Business owners need to understand this information so that when questions from lenders arise (and they certainly will) they can explain with confidence. When it comes to preparation and understanding of these financial statements, most businesses and their owners fall into one of the following three general categories:
Level 1 (basic) – maintains a cash-based income statement (periodically and not necessarily monthly), minimal understanding of the balance sheet and little to no forward-looking financial planning;
Level 2 (intermediate) – maintains an accrual-based balance sheet and income statement and possibly prepares a cash flow statement and some forward-looking financial planning;
Level 3 (advanced) – prepares monthly balance sheet, income statement and cash flow statement, 13-week cash flow or similar tool, key performance indicator (KPI) monitoring and at least one-year of financial projections.
Moving from one level to the next typically occurs over time and is contingent on the growth of the company and its utilization of in-sourced or out-sourced resources. Getting to Level 3 is accomplishable for any business seeking to grow. The minimal investment required to get there is often much smaller than the returns that come to those with better financial reporting.
While financing can be found for Level 1 companies, the closer a company gets to Level 3, the more likely it will find capital available for growth at a more attractive rate.
Eric Wingerter is a co-founder of the accrual-based bookkeeping provider, Correct Profit, and a partner with Emerge Dynamics.
as also published in New Orleans City Business – https://neworleanscitybusiness.com/blog/2022/05/03/better-rates-and-more-capital-for-your-business-growth/