Does Your Banker Trust Your Financials?
Jan 21, 2013
If you were to walk into a bank to seek financing for your business, how confident would you feel when the loan officer asks to see the last three years of your business’ financials? How quickly could you produce the financials and how much faith would you have that they accurately reflect the true condition of your business?
Having met with numerous bankers over the course of several years, a common comment has been the poor quality of the financials of small businesses. As I talk with business owners about the state of their business, we eventually get to the point of reviewing the financials. Many are often almost apologetic about the quality of their financial reports as a whole but are more likely to feel most confident about the income statement.
When pressed as to the accuracy of the amounts reflected in the various accounts and whether or not everything owned or owed by the business is contained within the balance sheet, the response is less than enthusiastic. What most business owners do NOT realize is that the balance sheet is the foundation for the income and cash flow statements. The income statement is a cumulative record of revenues and expenses for a period of time, the results of which is reported in a single line in the Equity section of the balance sheet. One can take balance sheets for two different periods and build a statement of cash flows. In my estimation the balance sheet is the most important of the statements, yet it is usually the most neglected. Because of constraints in the length of the article, I will limit my discussion to the balance sheet.
So, what does a business owner need to do to the make the balance sheet something in which they can have confidence and more importantly be a useful tool for managing their business? Without giving the reader a drink with a firehose, I will provide a few high level suggestions for making the balance sheet a statement for which the owner can be proud.
Balance Sheet: There are five main, and important, sections to the balance sheet. The balance sheet is in balance when the total dollar amount of Assets reported is equal to the total of the Liabilities plus the Equity amounts that are reported.
The Asset part of the balance sheet reflects what the business OWNS and is divided into two main sections - Current Assets and Fixed (or long term) Assets. What the business OWES is the sum of the Liabilities and Equity parts of the balance sheet. Two sections are contained in the Liability part of the balance sheet, current liabilities and long term liabilities. While there might be many accounts, the Equity section stands on its own.
The owner should ensure that two things are done consistently. First, there should be an account for each and every significant item that he business owns or debt obligations owns in which to capture the dollar value of that item. This doesn’t mean that every item should have its own account, It means there should be a “bucket” for every meaningful item owned (asset) and every significant debt owed (liability). One of the most frequent mistakes I see owners make is that they fail to include everything that is use in the business on the balance sheet.
The second “fix” the owner can make is to ensure that the amounts recorded in each balance sheet account can be reconciled to an external document. For instance the balance in the checking account should be reconciled each month to the statement provided by the bank. The amount recorded for inventory should be validated by a periodic physical inventory at least once a year and a perpetual inventory system used to keep an accurate running total. Sales on account and purchases on account should be recorded as soon as the sales or purchase event occurs so that balances in accounts receivable and accounts payable are current. The total of all the individual accounts receivable or accounts payable accounts must equal the amount reported on the balance sheet. Debt obligations, whether current or long term, should be reconciled to the periodic statements provided by the lender. Also, ALL amounts the owner has invested in the business, whether cash or property should be recorded as owner contribution in the Equity Section.
The balance sheet is a very important statement, especially when you are seeking financing. This article presents two actions that an owner can take that will yield a financial statement the the owner can be proud of and the banker (lender) will trust.