Analytical Tools and Debt Structure

Keep Tabs on Your Business Using Three Basic Documents

     Over the years, many companies have asked me to help them obtain financing for their company. Often, a shortage of cash to pay vendors or meet payroll was the first indicator that they needed to borrow. Sadly, by the time some companies realize they need a line of credit, their financial condition makes them ineligible for one. So, just when they need credit the most, they are least likely to get it.

     In many cases, this scenario can be avoided through a regular review of the company’s financial statements. This assumes, of course, that the financial statements are accurate, so if you don’t have a CPA firm that reviews your financial information periodically, hiring one should be one of your highest priorities.

     You can obtain the information you need for a periodic review by reviewing three documents-Balance Sheet, Income Statement and Statement of Cash Flows-and performing basic ratio analysis. It is essential that you use all of these tools in conjunction with each other to gain a complete picture of your financial situation.

     The Balance Sheet is a list of the items owned by the business (assets), and where the money came from to pay for those items: the owners (equity) or third parties (liabilities). This document shows how quickly a company can raise cash (liquidity), and whether the business has too much debt (leverage).

     The Income Statement shows how much money the company earns from selling its product and the expenses incurred to earn that money. This document is used to determine overall profitability, or how well the company covers its basic expenses, and whether sufficient funds are available for such things as research and development, debt payments, and increasing the cash reserve.

     The Statement of Cash Flows shows the company’s true cash position. It is a necessary document because most companies use an accrual accounting system, which only tracks income and expenses, but not cash.

     Finally, Ratio Analysis makes it possible for you to compare financial results from one period to the next, so you can measure your progress and determine what areas of your operations require your attention.

     Your financial review will help you determine how much you have to borrow, and whether you have a short term or long term financial need. Always match the term of the debt with the term of the need. Receivable and inventory purchases are short term needs. Capital asset purchases, such as machinery, building or land, are long term needs.

Originally published in Kaufmann’s Capital Comments.
Practical Information. Process Improvement. Profit Enhancement.