Past Financial Statements Are The Cornerstone of The Financial Profile
The cornerstone to any financial profile is historical financial statements of the company. A well developed profile will contain 3 years of accountant prepared financial statements and business income tax returns for the last three completed fiscal year ends of the business.
Accountant prepared financial statements should include the type of engagement, the name and signature of the accountant that prepared the financial statements, and any notes to the financial statements.
Engagements can be Compilation, Review, or Audit with audit being the highest level of review that an accountant will perform. Some sources of financing will not consider applications done under a Compilation Review, or if they do, they may have limits as to how much money they will be prepared to consider providing, and what terms they are prepared to offer.
Therefore, one way to strengthen a business financial profile is by investing in a higher level of accountant engagement.
Another potential factor with accountant prepared financial statements is the size of the accounting firm that completes the work. In general terms, greater reliance is placed on financial statements provided by larger accounting firms.
For instance, it’s likely that financial statements prepared by an accountant that is a solopreneur may be relied on to a lesser extent by a financing company that if the accountant was an employee or partner of a larger accounting organization. This is not to automatically say that bigger is better, but in general terms, the financing community believes that there will be greater independence in the work performed and the opinion provided from larger firms.
The information presentation and formatting can also be important. For instance, financing providers prefer to look at accountant prepared financial statements where both the current year and previous year are present side by side to provide for easier direct comparison of fiscal periods.
It’s also preferred to have financial statements include a balance sheet, income statement, statement of retained earnings, statement of cash flows, and notes that provide further explanation about the business performance to the reader.
When more information is included in the financial statements, its likely going to cost more in the review and preparation fees, but it also provides a more complete history of your business, which can aid greatly in the assessment of your business financing request.
Not all financing companies will ask to receive both the financial statements and the business income tax return, but its important to have both readily available if required.
Copies of all past financial statements and income tax returns for at least the last 3 years should be held at the business office or online so that when information is requested it is readily available.
In many cases, the business will ask their accountant to provide copies of any missing information as accountants keep copies of information they prepare on behalf of clients.
However, there can be instances where your accountant is away from their office for a few weeks, or a larger accounting firm taking considerable time to respond to your request. These are just a few of the reasons why a business should maintain a complete and up to date copy of their past financial statements.
In many ways, the incremental cost of higher accountant engagement and expanded content can be viewed as a cost of financing as it can 1) increase your access to business financing, and 2) lower your cost of capital.
In terms of the actual financial review of the information, this can also vary tremendously from one financing company to the next.
When a lender evaluates a business’s historical annual financial statements to support a loan request, several types of financial analysis are typically conducted to assess the business's past performance and gauge its ability to repay the loan. These analyses aim to understand the business's financial health, stability, profitability, and trends over time.
So as a general guideline, here is list of reviews that could be performed by a financing provider. The actual amount and level of review that is performed will vary by financing request and targeted lender.
The more information you provide, the greater their sense of comfort tends to be when performing a financial review, especially for larger and/or more complex capital requests.
1. Trend Analysis
Year-over-Year Growth: Examines revenue, profit, and expense trends over multiple years to identify growth patterns or concerning fluctuations.
Historical Margin Analysis: Looks at gross, operating, and net margins over time to assess profitability and cost management.
2. Ratio Analysis
Liquidity Ratios: Such as the current ratio and quick ratio, to evaluate the company's ability to meet short-term obligations.
Solvency Ratios: Including debt-to-equity and times interest earned ratios, to assess long-term financial stability and debt management.
Profitability Ratios: Such as return on assets (ROA), return on equity (ROE), and profit margins, to determine the company's efficiency in generating profit.
Efficiency Ratios: Like inventory turnover, accounts receivable turnover, and asset turnover ratios, to evaluate how efficiently the company uses its assets.
3. Comparative Analysis
Industry Benchmarking: Comparing the company's financial metrics with industry averages to evaluate its performance relative to peers.
Competitive Positioning: Analyzing the company's financial strength in comparison to key competitors.
4. Cash Flow Analysis
Operating Cash Flow: Assessing cash generated from core business operations.
Free Cash Flow: Evaluating the cash available after accounting for capital expenditures, to understand the business's flexibility for paying dividends, reducing debt, or reinvesting in operations.
Cash Flow Trends: Identifying patterns in how cash is generated and used, highlighting potential liquidity risks or operational inefficiencies.
5. Quality of Earnings
Assessing the sustainability and reliability of earnings, including the identification of non-operating, non-recurring, or unusual income or expenses that might distort the true financial performance.
6. Capital Structure Analysis
Evaluating the mix of debt and equity financing, examining terms of debt, and understanding how the capital structure supports the company's growth and stability.
7. Contingent Liabilities
Identifying and assessing potential liabilities not fully recorded in the financial statements, such as lawsuits, tax audits, or warranty obligations, that could impact the company's financial health.
8. Management Performance
Assessing management's effectiveness in using resources and making strategic decisions based on financial outcomes and strategic initiatives reflected in the financial statements.
These analyses provide a comprehensive view of the business's historical financial performance, offering insights into its operational efficiency, financial stability, and potential future performance.
This information helps finance companies make more informed decisions regarding capital requests.