Your financial statements are a powerful tool — but like any tool, you need to know how to use them to the best effect. Many business owners and bookkeepers know that financial statements are important but don't utilize them to their full potential.
Your reports have so much information, but data is just data. Interpreting those numbers is crucial if you want your business to thrive and grow; correctly presenting that data is the difference between someone investing in your business or bailing out.
Why Investors Want Your Financial Statement
People looking to invest in your business or lend money want some assurance that your company will grow. More importantly, they ask this question: Is your business profitable?
They won't necessarily want your forecast. However, many business owners think this is the right document to present. Savvy investors will ask for your historical data — your financial statement, which is your balance sheet, income statement, and cash flow. Wielding your historical data effectively can help boost investor confidence, and showing them your financial statement lets them see the growth of your business.
Remember: historical information is essential to managing a business and forecasting!
Understanding Your Numbers
The numbers you present in your financial statement create a snapshot of your business. It answers a lot of questions, including but not limited to:
Are you having cash flow problems?
How quickly do you turn inventory into cash?
Can you pay your suppliers for a long time, or do you need to negotiate with them?
Is your business profitable?
In essence, this critical document can present your company's health to investors, lenders, stockholders, and stakeholders. As a business for good and the sake of transparency, having clear, accurate data is essential to ensuring that everyone is on the same page.
Your investors will also want to know this data to determine when you’ll need capital again, if at all. One golden nugget from Christina:
“How long are you going to last? If you are raising $5 million? Are you going to need another $5 million in 12 months? And so it's very, very important to understand the relationship between the income statement to the balance sheet because you want to be confident when you are talking to your investor and basically say, ‘This is how much capital I need. And it's going to last me x months, hopefully months or even years before.’”
The Three Essential Reports
Your financial statement comprises three things: an income statement, balance sheet, and cash flow statement. Used together, these three documents provide a lot of critical information about your business.
Income statement
Your income statement measures revenue against expenses. In a nutshell, this statement will describe whether or not you can support the cost of doing business. When you calculate your revenue minus cost, you get your gross margin — an important number for understanding the health of your business.
Furthermore, you can get your EBITDA from your income statement. EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization and represents net income or loss, which in turn shows your company's profitability. However, remember that profitability is not necessarily cash!
Balance sheet
“One of the key things why investors want to look at is the balance sheet — they want to know what the business owns, and what the business owes.”
A simple way to understand what's on your balance sheet is this: if it's an asset, that's what your business owns. If there's a liability, that's what our business owes. A balance sheet is cumulative and should show everything from the beginning of your business.
Ideally, what you own should be higher than what you owe. Furthermore, debt capital can give an insight into your business growth.
Cash flow statement
Finally, your cash flow statement records how you generate revenue and the cost of generating that revenue. It also shows financing: how much your business received from investors, including your own. Finally, it shows the cash used to build revenue-generating assets.
It’s vital to remember that although these three documents can affect each other, that’s not always the case. Something might only affect your balance sheet or just your income statement.
Capitalizing On Revenue-Generating Assets
One critical thing many founders miss is understanding how to present the cost of their assets. Many founders don't put the cost of building their assets on the balance sheet. However, this is a grave error and leads to a loss in profitability.
“...if you understand that is a part of building an asset for future revenue generation, you know that it has to be capitalized, and it will sit as fixed asset on your balance sheet, you are increasing your profitability by $1.5 million.”
It’s essential to capitalize on all your expenses as much as possible!
Creating a Robust Financial Statement
If your company is relatively new, your financial statement might not need all the components — for instance, in the pre-seed and seed stages, you'll need at least your current assets, accounts receivables, and current liabilities.
However, it's good practice to start making in-depth financial statements as early as possible so you can present them later. Remember to categorize every single transaction correctly! Always determine whether you can capitalize on something in your financial statement.
Making it a monthly habit to take your bank statements and translate them into the three essential reports would benefit you a lot. Therefore, it's also a good idea to hire a good bookkeeper or seek the assistance of a CFO to ensure that all your numbers are correct and presented appropriately. Your financial statements can make or break your company, so it's in your best interest to get them done right.
If you want to grow your team and take your business to the next level, a CFO can help you figure out your next best move. Understand how to price fairly yet competitively and maximize your profits with the help of a finance team. Schedule a discovery call with Profit Reimagined™ to help you cover your foundations and deepen your understanding of these concepts.