Lending to a business?
Lending to a business owner?
Either way, you undoubtedly ask for and receive a year-to-date financial statement. Here are eight questions to ask (yourself or your borrower) before you stuff it in the file.
- Evaluate the preparer.
- Was it prepared by a CPA or accountant you trust?
- Was it prepared by the borrower’s in-house accountant who you believe has the skill to provide accurate information?
- Was it prepared by the business owner using software that kicks out a statement that looks good but might be ‘garbage-in-garbage-out’?
- If not, can you pull out a balance sheet for the same date from your files to compare?
- Run your finger down the page and note any major swings in assets, liabilities or capital (equity).
- Do they make sense?
- Any questions for the borrower?
- Cash balances
- Working capital: Current assets minus current liabilities
- Current ratio and quick ratio. Compare these to industry averages
- Calculate Debt to Equity ratio and compare to industry averages
- If low compared to their usual ratio or the industry, what is the reason for their caution? This is not a bad thing at all but helpful to understand.
- If high compared to their usual ratio or the industry, consider if they have sufficient personal net worth that perhaps it is not an issue. Small business owners often take all the income home and, if more than they need for living expense and personal debt, ‘store it’ in their own balance sheet.
Time to order our self-study manual on Financial Statement Analysis: Understand the Business Scorecard if:
- You are unfamiliar with any of the items listed
- You are familiar with them but could not explain what they mean to your customer (which tells me maybe you are not crystal clear yourself)
- Your software calculates ratios and percentages but you couldn’t do them with just the balance sheet and a calculator
Now, more than ever, you need to gather actionable information from the financial statements you are getting from your borrowers.
What are you looking for on financial statements?