What is somebody looking for when they ask you to send them your company’s financials?

It’s three things:

  1. Income Statement (also known as a Profit & Loss Statement or P&L)
  2. Balance Sheet
  3. Statement of Cash Flows.

These statements tell the reader how your company is performing (P&L), its current financial condition (balance sheet), and how it generates and uses cash (statement of cash flows). They can be easily generated from accounting software such as SageIntacct or QuickBooks.

The presentation of the financials is as important as what they contain. A four-page long balance sheet with funky balances is going to concern a reader – he or she will think your accounting system is not accurate. Today’s blog explains what you should provide and what an investor and lender is looking for with each statement. I’ll also explain what EBITDA is and why everybody wants to know it.

Click here to see a sample of the financial statements referenced below.

The P&L Shows Financial Performance

A P&L shows your company’s income and expenses. It’s an indicator of the performance of your company and includes in the order below:

Sales
Gross sales are your products/services sold at list price.  Net sales subtract from gross sales certain reductions as discounts or returns.

Gross profit
Net sales less cost of sales. This is how much margin your company is generating to cover operating expenses and profit.  Most P&Ls include a calculation of the gross margin % of net sales.

Operating expenses
Costs to operate your company. For fast-growing companies, payroll is often the biggest expense, followed by sales & marketing. Things like facilities costs, travel & entertainment, insurance, etc. are included here.

EBITDA: Earnings Before Interest, Taxes, Depreciation & Amortization.
Gross profit minus operating expenses.  This is an approximation of your company’s operating cash flow – that’s why banks and investors are so interested in it.

Other Income (Expense)
Non-operating expenses such as interest expense and one-time writeoffs.

Net Income
The net profitability of your company after accounting for all income and expenses.

Investors review a P&L to get an idea of the size of your business, its profitability, and where you are investing. They want to get a sense of the value of the company and its cash needs. A lender is more concerned with cash flow… can your company service its debt to them?

A Balance Sheet is Your Company’s Current Financial Condition

A Balance Sheet is a snapshot in time of your company’s financial condition. It gives provides the reader a sense of what your company owns (assets), what it owes (liabilities) and what it is worth (equity). This is the “balance” in balance sheet: Assets = Liabilities + Equity.

Assets
This section is divided into several areas:

  • Current assets contain items the company owns with a useful life less than 12 months. This includes cash, accounts receivable, inventory, prepaid and other current assets.
  • Fixed assets are items with a useful life greater than 12 months. These tend to be larger dollar amounts and are depreciated over time.
  • Other assets also have a useful life greater than 12 months. Patents and organization costs are examples of Other Assets.

Liabilities
Like assets, liabilities are grouped into short-term and long-term. Short term liabilities are accounts payable, corporate paid credit cards and accrued expenses (expenses incurred now and paid later, like payroll taxes). Long-term liabilities have a useful life over 12 months. For example, the balance of a five-year loan made to your company would be listed here.

Equity
This section shows the net worth of your company – what remains when you subtract liabilities from assets. It contains the amount of capital contributed to the company and the cumulative earnings of the company since it was formed. If you have a partnership, then the amount of capital distributed to partners is also listed here.

I feel a balance sheet is more important to a lender than an investor. Lenders are more risk-averse than investors, so they want to make sure the company they are lending to is healthy enough to service the debt. They will spend a lot of time reviewing assets to see how they can be used as collateral, as well as the debt currently on the books to make sure the lender is in a good position to be paid back. Investors want to know that the company they are buying into has quality assets and has also properly recorded all liabilities… investors want to know exactly what they are buying into.  Both investors and lenders are big on searching for unrecorded liabilities – amounts your company owes but are not recorded on the balance sheet.

The Statement of Cash Flows Shows How Cash is Generated and Used

The Statement of Cash Flows is the most overlooked statement, however, I feel it is the most important. It’s tough for most people to grasp because of how it is prepared… it shows changes to the balance sheet and doesn’t answer questions like “how cash did we use on payroll this month?” This indirect method is used because it is very difficult to prepare any other way. It does give us valuable information on cash flow from operations, investments and financing.

Operating cash flow
This statement takes net income and reconciles it to cash using adjustments to balance sheet accounts like accounts receivable and payable. It will not give you granular detail on exactly what you spent your cash on but it will provide operating cash flow that you can compare to your EBITA mentioned above. Now you see why people want to see EBITDA. It will provide the level of detail people want to see but it will not exactly match what’s on the Statement of Cash Flows

Investing cash flow
Cash flows from investing activities involve cash used to acquire or dispose fixed and other assets – those with a useful life greater than 12 months.

Financing cash flow
Cash flows from financing activities include anything that impacts the capital in your company: borrowing money, selling stock to investors, taking partner distributions, etc.

Investors and lenders review the statement of cash flows to get a sense of how the company generates and uses cash. They will expect an early-stage company to have negative operating cash flow financed by debt or equity. What they are trying to understand is the difference between operating and financing cash flow. They are looking at several things: how much cash your company needs, how long it may last and whether there are any structural issues (such as low gross margins) that may make it difficult for the business to generate cash.

 

Some Tips When Giving Out Financials

  • Never give out mid-month financials. Always run them for the latest month you have closed the books.
  • Summarize data into key groupings. You can always provide more detail during due diligence.
  • Disclose up front anything in your financials that may make a reader uncomfortable. This shows that you are aware of any potential issues and builds trust with the reader.
  • The first set of financials you provide will set the stage for future conversations. Keep the process moving by sending out clear, understandable statements that keep the discussion moving.