SME Lending – Financial Statements
As a Business Finance Professional and adviser to small and medium businesses, you will analyse and help SME owners develop and maintain business financial statements.
Financial Statements detail a business’s financial activity. They provide a situational snapshot and assist in forecasting future goals, objectives and operational plans of the business.
The foundation of sound financial statements is quality bookkeeping. Making clients aware of the fundamental importance of maintaining up to date organisational data is a great benefit when it comes to compiling financial statements.
As well as being an integral part of any business plan and a key to future business decision making, financial statements have an essential role when it comes to attracting investors or obtaining finance. Well presented, accurate and informative financial statements can be the difference between securing funding and missing out. Which, in turn, can impact on business success.
The Three Statement Model
A Three-statement model links the income statement, balance sheet and cash flow statement into one dynamically connected financial model. Three-statement models are the foundation on which more advanced financial models are built, such as discounted cash flow models, merger models, leveraged buyout (LBO) models, and others.
1 - Income Statement
The income statement shows the performance of the business over a period. It displays sales revenue at the very top, then deducts the cost of goods sold (COGS) to determine gross profit. This gross profit is then affected by other operating expenses and income, dependent on the nature of the business, to calculate net income – “the bottom line”.
Key features:
Displays business revenue and expenses
Expressed across time periods (Year to Date, Yearly, Quarterly, etc.)
Used to assess profitability
2 - Balance Sheet
The balance sheet displays the business’s assets, liabilities, and shareholders’ equity. Assets less liabilities equals equity. The asset section starts with cash and equivalents, which are linked and the same as the cash flow statement balance. Changes in each major account of the balance sheet are then recorded. The balance sheet will also display retained earnings, which comes from the net income in the income statement adjusted for payment of dividends.
Key features:
Displays the business’s financial position
Expressed as a “snapshot” at a point in time (e.g., as at June 30, 20xx)
Has three sections: assets, liabilities, and shareholders’ equity
Assets = Liabilities + Shareholders’ Equity
Working Capital = Current Assets – Current Liabilities
Cash Flow Statement
The basis for the cash flow statement is the net income from the income statement, which is then adjusted for any non-cash expenses. The balance sheet is then used to uncover the receipt and usage of cash. The result is reporting on the end balance of cash, the starting balance of cash and therefore changes in cash over the reporting period.
Key features:
Displays decreases and increases in cash
Expressed across time periods (Year to Date, Yearly, Quarterly, etc.)
Displays pure cash movements, disregarding accounting principles
Includes three parts: cash for operations, cash investments, and cash financing
Displays the net change in the cash balance from start to end of a period
The numbers found on a company’s financial statements are used to perform quantitative analysis and assess a company’s liquidity, leverage, growth, margins, profitability, rates of return, valuation, and more.
The Key Elements of Financial Statements
Financial Statements rely on five well defined and appropriately reported elements - assets, liabilities, equity, revenues and expenses.
How these five elements are portrayed in financial statements is essential as it provides information to both internal and external stakeholders. Lenders and finance companies rely on this information in formulating their decisions. Analysis of the information may include questions such as
Is revenue lower for this period compared to the last period? Is this an issue?
Do substantial liabilities on the balance sheet signify a business has taken on too much debt?
If accounting revenue is high, but cash flow is low, is there a problem with client payments?
How does the business compare to similar businesses in the industry?
Assets are the resources in a business that have economic value and generate future benefit. Assets are reported on the balance sheet and include items such as property, equipment, cash, accounts receivable and stock/inventory.
Liabilities are a business’s financial debts or anything it is obligated to pay. Wages, taxes and accounts payable are business liabilities. Liabilities differ from expenses, as expenses directly reduce business income in the financial statements.
On the balance sheet, liabilities are subtracted from assets to display Shareholder
Equity. Equity can also be defined as the amount shareholders invest in the business plus retained earnings (money a business makes and doesn’t spend or distribute as dividends). Comparing balance sheet equity and shareholder equity can provide a snapshot of business health. If assets of a business decrease, or if it is holding a lot of debt, balance sheet equity can be less than shareholder contributions.
Revenue is the income a business generates. Revenue can be separated into operating revenue and non-operating revenue. Operating revenue is from the sale of products and/or services. Non-operating revenue is generated from other non-core/secondary sources such as interest, sale of assets and investment returns. Depending on the accounting methodology used by the business, revenue can be reported when it is paid (cash basis) or when it becomes payable. e.g. on job completion or invoicing (accrual basis).
Expenses are the costs a business incurs in generating revenue. Accounting fees, bank charges rent, travel costs, utilities and salaries are examples of expenses. Depreciation, which is the devaluation component of an asset's value, is also an expense. Included in operating costs is the cost of goods sold, which are expenses directly tied to the production of goods and services – for example, direct material costs. Again, there are two accounting methodologies that can be used to report expenses. For cash basis reporting, expenses are recorded when the bill is paid. Under the accrual basis, the expense is recorded as soon as it is incurred.
In conjunction with industry experts, elevateB has developed a self-paced, online, interactive Business Finance Certification. This program will provide you with the knowledge and skills required to become a successful Business Finance Professional. In addition, it provides strategies and soft skills to assist you to better market and deliver your existing and new-found client offerings.
For more information on the Business Finance Certification, click here.