October 14, 2021
3 Financial Reports to Run Before Pursuing a Business Loan
- Determine your business funding needs.
- Figure out the size and frequency of payments you can afford.
- Learn what types of financing you might qualify for.
- Quickly answer questions from prospective business loan lenders.
- Evaluate how to use loan funds to maximize ROI.
The Financial Reports to Run Prior to Applying for a Business Loan
1. Balance Sheet
Your balance sheet shows what your small business owns, what it owes, and how much has been invested in it. The accounts contained in your balance sheet include: Assets: your holdings, such as cash, inventories, receivables, property, equipment, and intangible assets. Liabilities: what you owe, such as accounts payable, taxes owed, and other financial liabilities. Equity accounts: includes all the stock you’ve issued, retained earnings, and paid-in capital. Since the balance sheet provides a summary of your business’s financial position, business loan lenders often look at this statement first. However, without also evaluating the next two reports on this list the balance sheet has limited utility. That said, it’s worth noting that if your balance sheet shows more liabilities than assets, qualifying for a loan may not be feasible. As Investopedia explains: “If a company's liabilities exceed its assets, this is a sign of asset deficiency and an indicator the company may default on its obligations and be headed for bankruptcy”2. Income Statement
Your income statement lists your business’s revenue, expenses, and profit or loss over a designated time. Revenue and expenses may be broken down differently depending on your small business's industry, operating activities, and other factors. Regardless of format, though, income statements are meant to present your business’s financial results. Income statements are an important tool for business lenders because it helps them determine the sustainability of your profits. Lenders will typically use your income statement to analyze your profit margins and sales volume. Depending on the type of financing that you’re pursuing, lenders might use sales volume or revenue as qualification criteria. For example, many business lenders require a minimum annual revenue number for borrowers to be eligible. Your income statement is where you’ll find revenue and sales info so you can quickly determine whether you meet minimum eligibility criteria.3. Statement of Cash Flows
Not all small businesses publish a statement of cash flows, but most business lenders will require this business financial statement. As the name implies, the cash flow statement shows the flow of cash in and out of your business. Cash flow statements are an important document to review because revenue on an income statement may not reflect cash flowing to the business. For example, suppose accrual accounting is used and the income statement shows $250,000 of profit in August. Without the cash flow statement, you might assume that the company had $250,000 with which to make payments in August. However, because accrual accounting recognizes sales when they’re posted, the cash from that sale may not actually arrive until October. For a lender, this is a big deal because borrowers need cash to make their payments. For the same reason, cash flow statements are critical to you too. Using your cash flow statement, you can accurately determine how much cash you have available to make loan payments.Key Financial Metrics and Ratios to Review
Using figures from the three business financing reports listed above, lenders will calculate a few important ratios. These ratios include: Quick ratio: this indicates a company’s ability to pay off its short-term obligations with its most liquid assets. To calculate the quick ratio, lenders use your balance sheet to determine the value of your liquid assets, such as cash. Then they divide that by the value of your short-term liabilities. Debt-to-income ratio: this ratio tells lenders how much of your monthly income goes to debt payments. Many lenders set a maximum debt-to-income ratio (DTI) as part of their eligibility criteria. As you’re browsing loans, knowing your DTI can help you quickly eliminate options you’re not eligible for. Debt-to-cash flow ratio: the debt-to-cash flow ratio compares your monthly cash flow to debt. It’s similar to DTI but replaces monthly income with monthly cash flow to create a truer picture of the cash available for payments.