Understanding the Basics of Financial Statements

When you look at acquiring a business, you are generally given a couple of Quick Key Indicators to get your attention and to gauge your interest level.  Example: Commercial Construction Company, Asking Price : $7,500,000, Gross Revenues: $13,500,000, Cash Flow or EBITDA $2,500,000, etc.  If these float your boat, the next step is to look at the financials.  You hope it is this good!  Let’s look at the basics.

Basic Working Knowledge

As a business owner, be it small, medium or larger, you’ll want a basic working knowledge on how to read and analyze financial statements. Once you understand the Key Component Basics regarding financial statements, you can make strategic business decisions as well as identify challenges and opportunities within the business.

Bankers and Lenders

More than likely you will be considering an SBA or bank loan. The bank or other lender will want to see certain basic documents of the business. What are these documents? Your success obtaining these private documents and then being able to answer basic questions the banker will ask is all important. Think of it as a window. Both you and the banker are looking through a window. You probably cannot take him or her physically inside the business itself.  So, what you both are doing is looking at the company’s financial position to access its overall health. If it is healthy, the banker hugs you and offers you coffee.  If it is not, or does not appear to be healthy, he shakes your hand and excuses himself as quickly as possible saying he has another customer waiting.

What are the Financial Documents and What are You Looking For?

There are dozens, depending on the size, category and record keeping. Knowing which are key and their key ‘bullet points’ are the difference between hugs and shrugs. Here are the top three.

Your Buyer’s Rep knows that the Financial statements provide insight Bankers and Lenders are looking for and this where is having an accountant or CPA on your Team comes into play.

#1 The Income Statement

More often simply called the Profit and Loss (P&L) Statement, the Income Statement summarizes a company’s revenue minus the expenses. It is Number One. You will want to have the ‘Current Year to Date’ P&L and the last three years of P&Ls printed and in hand when you walk into the bank.  

#2 The Balance Sheet

The balance sheet gives a clear view of assets, liabilities, and equity at a single point in time. Assets are anything that the company owns of value. This could be (1.) cash, (2.) accounts receivable and (3.) inventory, and (4.) ALL the tangible stuff it owns, like buildings, vehicles, heavy equipment. (Each may have its own separate printed report).

Liabilities

You are asking for a Bank loan.  More debt to be plied on. The banker wants to see what, and how much debt is currently owed. Typically, this will be any existing bank or personal loans, vehicle loans, rent and utility payments and, here’s the Big One: Taxes.

What is Equity and Why is This so Important?

Equity is the amount owned by the Owner or Owners, who are also called company shareholders. The main formula you need to understand on a balance sheet is:  Assets = Liabilities + Equity.  I know that sounds a bit backwards, doesn’t it? That’s why you need this information before going to see a loan officer. This is important because this is how he thinks and you don’t want to find your head spinning when he asks you in such terms.

How Does Your Consultant Analyze a Balance Sheet?

Short answer? I’m looking for warning signs within the business. As a Certified Business Analyst, when I analyze the balance sheet, I’m focused on recognizing any potential warning signs. It’s not magic. I use fundamental analysis to gain a better understanding of the company’s value and determine things like how much working capital is available, how quickly customers are paying their bills, the company’s debt to equity ratio, and operational efficiency. Knowing these metrics can help me help you make better-informed business decisions.

EBITDA

Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) is a metric to measure the profitability of a company. It is used by the Selling Broker to sell you on what a good deal a business for sale is by suggesting a multiple of the EBITDA. (X3, X4, X5, etc).

Buyer Beware! This is very helpful, that is true, and we all use it, but the devil is in the details. If you put 3 CPAs in a room, using the same Balance Sheet and Income Statement, you may have three different Net Profits conclusions. I look at the literal bottom line on an income statement, as well as the figurative bottom line to arrive at the final profit for the business and you should too.

#3 Tax Returns

I saved this for the end because the Seller may or may not hand these over until later in the Closing Process. It is great to have them as early as possible when making an Offer to Purchase, but the P&L and Balance sheet are enough for your first initial bank interview, The P&L and Balance sheet will indicate how much the company has paid in taxes.

The 30,000 Foot View

Generally, the Balance Sheet and the P&L / Income Statement can tell you and the banker the 30,000-foot view of the business’s financial story. Healthy?  Not healthy?

And, over a given period of time, in relation to the company’s expected performance, you can arrive at a fairly reasonable valuation proposition.  But keep this ever in mind, the ‘nuts and bolts’ of the business is so much more than its financial statements.

A Business Buyer Representative can help you navigate these somewhat obtuse areas in the pursuit of your goal to become a small business owner. On larger Mergers and Acquisitions, (M&A) you will no doubt have a team of players.  CPA, Attorney, Banker, to name a few.  Make sure you also have an M&A Adviser and Pro Business Consultant on your team who is none of those three. For Balance!

Comments are closed.