If your business is seeking to borrow funds or to find an investor who wants to invest in return for a share of the business, it is important that you understand the basis upon which they will make their decision.
Financial statements alone provide useful information both to business owners and potential investors.
Lenders and investors prefer to look in a little more detail at specific aspects of business performance. They need to be able to compare different businesses to decide which ones to lend to or invest in. They are also keen to see how businesses are doing over time, looking for trends that let them know if the business is heading in a direction they like.
Ratios are typically used to get this additional information. Some are simple percentages of profit to sales, but others rely on more specialized computations. Find out what the acceptable ratios are for your industry and country from national trade associations, chamber of commerce, or something similar. If the business is growing steadily, if there is always enough cash to meet bills when they fall due, and if borrowings are kept to a minimum, then your ratios are likely to be in an acceptable range. However, that might not meet the lender’s or investor’s criteria.
It is important to remember that lenders and investors will have their own criteria for what is acceptable in a ratio or trend and that different lenders or investors will have different criteria, sometimes wildly different.
Calculating financial ratios such as the below will give you a head start in the negotiations. If your application is rejected, you can set a target ratio for the next year or two and apply again when you have achieved your goal.
Banks tend to be inflexible when it comes to lending. If your business ratios are not in the acceptable range as decided by the banks risk committee, then you will not be offered a loan, or, if you are, it will be at a high interest rate. Investors tend to be more unpredictable. Some investors like to take risks and might be willing to overlook some unsatisfactory ratios if they can be convinced by the vision and drive of the owner, or if they can be convinced of the long-term potential of the product or service the business provides.
The key point to remember with financial information on your business, is that once it finds its way into another person’s hands, there is absolutely nothing more you can do about it. This alone should be reason enough to ensure that the information is accurate and shows off your business in the best light.
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