Understanding Financial Statements When Approaching Lenders

by Jeff Schein

"The bank is asking for our financial statements", these are 8 words that often bring apprehension to many business owners. They are a young and maybe struggling company, they need bank financing to survive, and they haven’t got a clue what the financial statements are telling them, what they should be looking at, or what the bank wants to see. Many will delay providing the required financial information to the bank, but this is the worst thing you can do. Going to the bank shouldn’t bring on apprehension. Having a basic understanding of financial statements and being prepared when you approach a bank, or any investor, will go a long way in reducing your apprehension.

The Basics

The bank, or any investor for that matter, uses financial statements to tell them what happened in the past. Statements are also used as a means to predict what will happen in the future. Creditors are concerned about whether income (cash flow) will be sufficient to cover interest and principal payments on their debt. Of course, predicting profits into the future is an uncertain science. For this reason, creditors use various analytical tools to help them assess and interpret key relationships and trends that will help them judge the potential of success in the future. It also helps them predict whether a firm has sufficient resources to handle a temporary financial crisis.

Financial statements are historical documents covering single time periods. Users of financial statements, however, are not so much concerned about the single time period as they are about the trends over time. Trend analysis is usually completed on key indicators, such as revenues, gross profit margin, operating expenses, and working capital components such as accounts receivable, accounts payable and inventory. Through comparison of ratios and trends you can make informed judgments as to the significance of results. That is why banks or other investors often want 2 or more years of business results before they will lend.

Although trends and ratios are a starting point, they can often raise questions, the answers to which you can only get through analyzing industry trends, economic factors and the company itself. Typically, unless you are a master of presenting information, bank lenders will ask questions of you and your business. This is normal as they are trying to learn as much as possible about you and your business. Once again, be prepared, this will show you understand your business and its finances and that will make the bank more comfortable in lending to you.

The Balance Sheet

Banks primarily lend off the balance sheet and the cash flow statement (primarily operational cash flow). That does no mean that the income statement is not important, it is, but the balance sheet essentially encompasses what happens on the income statement and the cash flow statement tells a lender whether you are actually generating enough free cash flow from which you can make debt payments.

So what is important on the balance sheet?

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