David R. Evanson
Where’s the Money, Fall, 1999
Financial statements shed light on the beast. That is, they help shareholders and investors stop groping with a shape in the dark, and gain an understanding of what the creature as a whole looks like. Is it a cash cow? Or is it a dog?
And while everybody understands why creditors and investors need these statements, there is considerably less information about how they use them to reach their investment decisions. In other words, what are your financial statements telling investors and creditors about your company?
AC vs. DC (i.e. LENDERS VERSUS EQUITY INVESTORS)
Right off the bat, there is an important distinction between how lenders and equity investors use these statements.
INFO BOX
Donzzt Forget: Lenders are looking at your financial statement to understand the companyzzs ability to repay debt. Equity investors are looking at your financial statements to understand your companyzzs ability to grow.
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To truly understand the behavior of your commercial lender, you need only visit the branch offices where the tellers are. There you will see people putting money in the bank, and others taking it out. The ones taking it out have every expectation the money will be there when they go to get it again — regardless of where itzzs been in the meantime. And the bank, as the custodian of the deposits, simply cannot afford to lose them. The bank runs a nice little spread business between what they pay you for your deposit and what they can get for lending it out again. As a financial institution, a bank is more accurately characterized as an intermediary than a risk taker. That is, the bank mediates the period of time that people want to borrow money vs. the time people are willing to lend it. As for losing money, theyzzre just not built that way.
Once you understand these principals, it speaks volumes to the behavior of your garden variety commercial lender. Loans are fully collateralized. If not, then they are personally guaranteed. Most likely, they are both. Where fixed assets are thin, or nonexistent, look for accounts receivable financing to be offered in place of term loans.
Little of this applies for equity investors. For instance, rather than the characteristics which demonstrate the ability to repay a loan, equity investors look for growth. After all, that and an oil patch underneath the shop floor is the only thing thatzzs going to make for an increase in value. In addition, equity investors try to understand the amount of capital which the company will require as it grows. If the company will require substantially more equity capital than the investor is able or prepared to provide, then perhaps itzzs not such a good investment.
The difference between the two can be summed up as follows: If a bank makes a loan to a company which subsequently triples sales and quadruples earnings, the return it enjoys will be the same as if the company never grew a percentage point. In fact, such growth may even alarm the bank since it could ultimately destabilize the company and undermine the ability to repay the loan. But for the equity investor, meteoric growth spells success, even if in the near term, it leads to significant variance in earnings in cash flow.
Thus oriented, these differing investors will approach your financial statements. Letzzs take a close look at the precise analysis each one undertakes.
INFO BOX
Donzzt Forget: Raising money is fundamentally an act of financial communications. To give investors — debt or equity — the confidence to cut you a check you must be able to speak knowledgeably and confidently on your companyzzs historical and projected financial performance.
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HOW LENDERS ANALYZE FINANCIAL STATEMENTS
Don Fracchia a lender and a senior vice president with Wells Fargo Bank, explains his approach. Though Wells Fargo has more than $52 billion in assets, and serves middle market as well as multi-billion dollar corporations, the bank also has a significant commitment to small business. The companyzzs business financing division focuses on small business with needs ranging from $50,000 to $2 million.
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Taking Action: Review your personal credit record and remove any unwarranted blemishes. Many lenders will include a review of he borrowerzzs personal credit history as a part of their analysis.
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Large or small however, Fracchia explains that banking credit analysis is broken down into three components. These are:
• The behavior or character of the company and its principals
• The primary source or repayment for a loan
• The secondary source of repayment for a loan.
While character canzzt be deduced from financial statements, itzzs a critical part of the analysis explains Fracchia. “Do the owners exhibit the type of character to pay back debts?” he asks himself. Interviews with principals, personal credit checks, public record searches, taken in the aggregate, yield important clues about how the company handles payment responsibilities.
Assuming the company passes this hurdle, Fracchia turns his attention to the financial statements, specifically the notes to the financial statements. These would seem rather pedestrian compared to the actual numbers, but in reality, they provide inquiring minds like Fracchiazzs a deep well of information “This is where I can get a brief history of the company, a detailed description of the debts, the current loan pricing, off-balance sheet items, pending litigation, and details regarding affiliated relationships.”
DETERMINING SOURCES OF REPAYMENT
In the three part credit analysis, Fracchia is trys to determine the primary source of repayment for the loan that you are requesting. Put another way, hezzs looking at the performance of the company to see what kind of debt it can support.
Itzzs important to note that if youzzre losing money, it that wonzzt necessarily scuttle the deal says Fracchia. “Small business owners make a conscious decision to carry the wealth in the business or to carry it personally,” he says. “In effect, they manage the bottom line. Salary, pension, profit sharing, any real estate that may be owned, are all discretionary. A loss does not end the game,” he says. “Youzzve got to see where itzzs coming from.”
Margin Analysis
But before reconstructing the income statement to see what kind of debt the company can support, Fracchia says most lenders will look at the gross, operating and net margins. The following paragraphs provide some insight about what these are and what they mean.
Mathematically the gross margin is calculated as follows:
Gross Profit
_______________ = Gross Margin %
Total Sales
The gross profit is: sales – cost of sales. That is if you sold lemonade, the primary cost of the sales would be the lemons. For example, if you sold $500 in lemonade and it cost $200 in lemons, the $200 is the cost of sales and the the $300 ($500 – $200) is the gross profit. When the gross profit is divided by the total sales, it is referred to as the gross profit margin. So what does the gross profit margin say? It tells you, and the lender how much of your profits get eaten up simply making the product or service.
Next, therezzs the operating margin which is calculated as follows:
Operating Profit
_______________ = Operating Margin %
Total Sales
Operating profit is the gross profit (see above) less what are known as the selling, general and administrative costs. Again, harking back to the lemonade stand, the lemons represent the cost of sales. But if your expenses for the stand, the signs, the uniforms, and permits are $200, then the operating profit is $100 ($300 Gross Profit – $150 Selling, General & Administrative Expenses). The operating profit, or margin tells the lender what the company makes in itzzs base business.
Finally therezzs the net margin, which is calculated as follows:
Net Profit
_____________________ = Net Margin %
Sales
What is the net profit? Itzzs the operating profit (see above) less gains and losses which might occur, but which are not in the normal course of business, less taxes. For instance, your lemonade stand might show an operating profit of $100. But if during the course of the year you sold a fully depreciated old lemon squeezer for say $25, you would have a gain of $25. Now the total income before taxes is $125. If the tax bite is $50 then your final net profit is $75. When this $75 is expressed as a percentage of the original $500 in sales ($75/$500) it indicates a net margin of 15 percent.
the first cut, Fracchia says he will compare the margins to industry averages which are published by banking trade group Robert Morris Associates to see if the company is up to snuff. For example, if restaurant chains on average have 65% gross margins, and youzzre only delivering a 50% margin, this sends up the red flag. You can see how you stack up against financial norms in your industry by purchasing a statement study from banking trade group Robert Morris Associates. Call 215-446-4000.
The most important of these performance margins says Fracchia is the operating margin — which consists of sales, less cost of goods sold, less selling, general and administrative expenses. “That tells me if the company is making money in its base business. If itzzs not, itzzs definitely a sign of trouble.”
Still says Fracchia, as mentioned, the dealzzs not completely dead yet if therezzs a loss. Salaries are discretionary. If the owner is taking an exceptionally healthy salary which is causing a loss at the operating level, then therezzs still hope — if he or she is willing to compromise. Compromise in this context means the business owner would, going forward, be willing to leave in the business, cash which they have historically taken out. This cash then becomes available to service the debt.
The Net Flow of Funds Calculation
Now comes the acid test. The net flow of funds calculation. In formula fashion, net flow of funds is as follows:
Net Flow of Funds = Net Income + Depreciation + Amortization + Extraordinary Items
Depreciation is the amount by which a companyzzs assets are devalued each year for wear and tear, while amortization represents the assignment of expenses to several intangble assets such as patents, trademarks or customer lists. These items are added back in because, even though they are shown on the income statement as an expense, they do not consume a companyzzs cash. For intance, if your companyzzs truck is depreciated every year by $500, itzzs counted as an expense, but this expense has no influence on cashflow. Thatzzs why itzzs added [italicize added] back to the Net Flow of Funds.
Extraordinary gains and losses — which are items such as insurance settlements from a fire, or the sale of an asset such as a truck, or damage to a facility — are added or subtracted from the net funds flow figure according to Fracchia, because “We want to understand the average [italicize average] net funds flow. If an extraordinary gain or a loss is just that, extraordinary — then we want to remove it from the picture.”
Sometimes net discretionary income — which is the amount of personal income a principal or officer takes from the company over and above personal and living expenses — is added to the net flow of funds. Itzzs used, says Fracchia, because if the individual is willing to kick some salary or bonus back into the corporation, those funds can help support the loan.
To pull all these concepts together into an example, consider a company with $65,000 in net income. If the company has total depreciation and amortization expenses of $25,000, a flood loss of $15,000 (where such losses have occured more than once over the past few years), and the company owner has agreed to take $25,000 less in salary, then the net flow of funds for this company is:
Net Flow of Funds = $65,000 + $25,000 – $15,000 + $25,000 = $100,000
In practice, Fracchia says the bank uses an average net funds flow for two years. So what kind of a loan can a company get assuming itzzs average net funds flow is $100,000? For secured loans, which are loans collateralized or backed up by a companyzzs assets,” says Fracchia “we want the ratio of net funds flow to annual debt service (i.e. net funds flow/annual debt service) to be at least 1.25.” Formulaically:
Net Flow of Funds
___________________ > = 1.25
Annual Debt Service
For the above-hypothetical company, with annual net flow of funds of $100,000 the annual debt service must be $80,000 or less in order for the coverage ratio of 1.25 to be met.
$135,000
__________ > = 1.25
$108,000
Put another way, if you are going to owe the bank $80,000 a year for a loan they are going to make, then bank wants you to show historical cashflow of at least $100,000 per year.
On a monthly basis, this $80,000 of debt service is about $6,700. Assuming a five year term loan at 12 percent interest, the 6.7 grand translates into a $300,000 loan.
INFO BOX
Shop Talk: The “coverage ratio” is the net flow of funds divided by the annual debt service. It shows how many times the debt service is covered [italicize covered] by the net flow of funds.
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BALANCE SHEET ANALYSIS
Next, Fracchia turns to the balance sheet. While the income statement analysis is fairly unequivocal in its purpose — to determine the primary source of repayment — the balance sheet is a little fuzzier. Part of the analysis is devoted to understanding the working capital needs of the business, and part of it is devoted to seeing if there are sufficient assets so that the loan can be recovered in the event of, financial deterioration.
INFO BOX
Shop Talk: The income statement shows performance over a quarter or a year. The balance sheet, by contrast takes a financial snapshot of the company at a single moment in time.
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Calculating Working Capital Needs
If you are seeking a loan to cover your cash needs, rather than say an equipment loan, Fracchia will look at your companyzzs trading cycle. That is, he will analyze the creation of accounts payable (i.e. the purchase of materials) to make inventory, which gets transformed, hopefully, into sales and accounts receivable. The speed with which the cycle occurs will determine the working capital needs of the company.
INFO BOX
A Good Deal: Many investors, debt and equity, prefer to finance working capital needs. Rather than putting funds at risk for product development, working capital investments allow them to participate in a companyzzs cash flows.
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To determine the actual need, Fracchia will look at the trend in turnover among the receivables, inventory and payable accounts. That is, how many days of sales are tied up in accounts receivable? Formulaically:
Average Receivables
Balance
___________________ = Days of Sales In Receivables
Average Daily Sales
The average receivable balance is what, on average, is owed to the company at any one time. And the average daily salers is the total sales divided by 365 — the number of days in a year.
For Example:
$100,000 in Avg. Receivables
____________________________= 20 days sales in receivables
$5,000 in Sales Per Day
At the most basic level, if a company has 20 days worth of sales tied up in receivables, such as the one above, it has a working capital need equivalent to $100,000. But if the days of sales in receivables are increasing, say by 15 days, because the length of collections is increasing, then the working capital needs increase by 15 days. In the above example the working capital needs would increase by $75,000 (15 days x $5,000)
What about inventory?
Average Inventory
__________________ = Days of Sales in Inventory
Average Daily Sales
For Example:
$300,000 in Average Inventory
____________________________= 60 days of sales in receivables
$5,000 Average Daily Sales
Suppose the company is turning over its inventory every 60 days last year, but every 90 days in the current year. In reality, this means the company is keeping on hand more of its product before it sells it. In this case the amount of additonal product the company is keeping on hand is equivilant to the amount that is sells every 30 days. As a result, it has a cash need equal to 30 days worth of sales.
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Shop Talk: A companyzzs operating cycle is equal to its dayszz sales in inventory plus its days sales in receivables. A company with 45 days in inventory and 30 days in receivables has a 75 day operating cycle.
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Fracchia will triangulate the trend in these accounts to determine the working capital needs of the company. Such needs are often addressed by what is commonly known as asset based financing. For more information on this topic see the earlier chapter titled Asset Based Loans.
By industry convention, there are limits to what lenders like Fracchia lend against these assets. For example, if hezzs lending against your accounts receivable, about the most he can let go is 70% of the average receivables. “That would be very aggressive.” If hezzs financing inventory, “We might fund up to 50%,” but again he cautions that the latter figure is on the aggressive side.
Finally, Fracchia will turn his attention to the right hand side of the balance sheet where the liabilities and shareholder equity is. First, hezzs going to look at the debts. By going to the notes, he can see who the lender is. If some of the debt comes from founders in the form of loans, thatzzs good and bad news. Itzzs good, because banks tend to count loans from founders as equity instead of debt, thereby increasing the ability of the company to secure more debt. Itzzs bad news because they do this by subordinating loans from shareholders to their loan. If your company needs cash, the bankzzs treatment of your loans to the company is more good than bad.
Any remaining debt, Fracchia will compare to the equity in the company, to gain a sense of how leveraged the company is. This is the debt to equity ratio or total liabilities, divided by total equity. For example, suppose your company has $2 million in debts, and $1 million in shareholder equity. Its debt to equity ratio is 2 ($2 million/$1 million). Depending on the industry, Fracchia says banks will generally goes as high as 4 on the debt to equity ratio — that is $1 of equity for every $4 of debt. “Anything over four is pushing the envelope,” he says.
Determining The Secondary Source of Repayment
When you are seeking a term loan, say for equipment or other fixed asset purchases, the balance sheet analysis takes on a different character. In this scenario, itzzs done to determine the secondary source of repayment, which is the final phase of the bankzzs three part analysis. Determining the secondary source of repayment, by the way, is a nice way of saying that the bank is trying to figure out if there are sufficient assets to liquidate and recover its principal in the event the borrower is unable to recover from a tailspin.
Itzzs for this reason, that Fracchia says most banks are not good collateral lenders. “If you can only lend to businesses where you will make a complete recovery in liquidation,” he says “then youzzre not going to be making many loans.” But lending without 100 percent coverage goes against a bankzzs grain. The funds are after all, not the bankzzs but depositorszz. Thatzzs why personal guarantees are standard on almost every small business loan. Still, liquidating a business ownerzzs personal assets to recover a loan can be a rather sticky affair that banks would rather avoid. Itzzs much, much easier, and probably a lot more pleasant when thing go south, to be a cash flow lender, providing funds against accounts receivable or inventory.
But this doesnzzt keep banks from seeing if the business can repay a loan in a liquidation scenario.
SIDEBAR: WHAT YOU HAVE WHEN THINGS GO SOUTH
As some rules of thumb to see how the secondary source of repayment stacks up banks typically assign the following values to assets:
• Accounts Receivable. Generally speaking lenders will assign a value to the accounts receivable of about 60% of what a company is showing on its books.
• Inventory. Figure anywhere from zero percent to 50 percent. The more of a commodity the inventory is, the more value it will be assigned. If you have rolled steel and aluminum ingots, youzzre probably looking at the 50% end of the spectrum. Then again if you have test tubes full of antigens, you might be looking at the other end.
• Equipment. The rule of thumb is that equipment will be worth about 60% of the net book value. The net book value is cost, less accumulated depreciation.
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Fracchia points out that liquidation is not necessarily standard operating procedure. “Banks arenzzt just looking at assets to see if they can be liquidated to pay off a loan,” he says. “We also want to see how much equity there might be in the companyzzs assets so that we can lend them more in the event their situation temporarily deteriorates, and they have cash needs.”
INFO BOX
A Good Deal: Financial statements which are prepared by a certified public accountant represent an excellent value in raising money because he or she can offer the perspective of an outside investor, and help you strengthen the presentation to appeal to their needs. Donzzt try to save on expenses by preparing financial statements on your own!
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HOW EQUITY INVESTORS ANALYZE FINANCIAL STATEMENTS
If youzzre an established company, that is, you actually have a track record of sales, and perhaps earnings, and you are seeking an equity investor in the form of a venture capitalist, an “angel” investor, or a corporate partner, the person on the other side of the table is going to look at your financial statements much, much differently, according to Peter Ligeti, a partner at Keystone Venture Capital Management, a venture capital firm. Keystone finances primarily established firms, which in venture capital parlance means companies with products and revenues, but perhaps a long way from profitability. As a result, Ligeti has seen a lot of financial statements.
Equity Investor Balance Sheet Analysis
To get an idea of the differences between lenders and equity investors at the broad brush level, consider Ligetizzs general outlook on the balance sheet. “We are much less concerned with the presence of assets to pay us out if there are problems. Whatever hard assets there may be, are likely pledged to the bank anyway. Our agenda is, we will invest regardless of the asset characteristics, if therezzs the opportunity to generate a large increase in value.”
So rather than looking at hard assets, Ligeti will zero in on the intangible assets. Whereas these arenzzt important to a lender, they are to an equity investor, especially for a growing technology company. For instance, if a company is capitalizing research and development (that is, treating R&D expenditures as if an asset was bought), thatzzs good. It shows a significant commitment to product development and improvement, which hopefully will fuel future sales. But if they are too aggressive in their allocation of R&D expenditures to assets, rather than expense accounts, thatzzs bad! A more conservative look at the companyzzs overall financial position might cause a reclassification of expenditures as expenses, and deliver a charge to earnings.
Next, Ligeti will look at the inventory to see if itzzs in sync with revenues. “If the inventory account is high relative to the revenues, or has been creeping up over time, thatzzs a big question mark for us,” he says. Maybe therezzs a big sale on the horizon. Maybe, however, the company is simply mismanaged.
On the accounts receivable, Ligeti will take a high interest in the revenue recognition policies — that is the companyzzs policy on when during the sales cycle it actually books its revenues. Growing companies, he says, sometimes push sales out the door. For investors this is bad because it makes profits look high, when in truth the cashflow might be very poor because customers are not paying as quickly as the company is counting their sales. In general Ligeti is looking at the sales to ensure that a high percentage of what are booked as sales are indeed done deals.
SIDEBAR: THE DISAPPEARING EQUITY INVESTMENT
Many equity investors will look very closely at the accounts payable section of the balance sheet before making an investment. Why? They want to see how much of their equity investment is going to get eaten by creditors. Sometimes a $500,000 investment, will get whittled down to $250,000 after the creditors stake their claim. So important are the accounts payable, many equity investors sometimes get on the phone to the creditors to see if they will hang in there a little longer.
The argument that you can make to the equity investor who balks at paying off accounts payable is that in order for the company to continue to grow, it must be on good footing with its suppliers. Specifically: “They got the company to where it is today. But theyzzre not investors. We have to replace their investment with real investment dollars before we can grow the company any further.”
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Moving on with the liabilities, most equity investors are looking for term loans. Ligeti says that most equity investors would prefer longer, rather than shorter term loans. Why? Shorter term loans require much more cash than long term loans, because the payment is divided by more periods. Also some term loans are interest only with a big balloon payment. The equity investor wants that balloon payment coming due as far into the future as possible
Moving along, accrued salaries payable to the owners can signal trouble for the equity investor, says Ligeti. The same goes for loans from the companyzzs owners. The problem is while the bankers simply subordinate these debts to their own, and then call them equity, not so with a venture capital investor. “We donzzt want to put in equity just so the shareholders can get paid.” he says. Itzzs the same with notes, or loans by the shareholders to the company. “We donzzt want to be in a position where we make an investment, and they walk away with their loans paid.”
According to Ligeti, what principals often call loans, venture capital investors call sweat equity. “Itzzs not always a constructive use of proceeds to pay off the owners of the business. They have a large stake in the company, which will be more than make up for accrued salary, or loans through appreciation in the value of their holdings.” That is, if this appreciation occurs.
Even if equity investors wonzzt pay off your loans, it may not be a bad idea to have them on your balance sheet. In particular, if you are underpaid from the start of your business, the difference between what you should [italicize should] get paid and what you do [italicize do] get paid ought to be logged as a loan to the company. Why? Because if way down the road, the company prospers on a grand scale, and it can afford to pay you back, with the loan documented from the get go, therezzs ammunition to make a case. If on the other hand, five years down the road you tell your equity investors that you feel the company owes you salary from the lean years, they will tell you to go pound sand. This highly likely set of circumstances is one very good reason that all companies, even very young, ones should have a set of financial statements prepared very early on.
Finally, Ligeti will look at the equity section of the balance sheet. As practical, he wants the lowest debt to equity ratio possible. Itzzs not that he has any aversion to bank debt, or financial leverage. He just wants to make sure that the company founders are his equity partners, and motivated to create an increase in value. After all, if the only real money in the business comes from lenders, then itzzs easier for the owners to walk away when the going gets tough.
Income Statement Analysis For the Equity Investor
Next, Ligeti will dig into the statements of income, and cash flow. Of these, the cash flow statement will provide more information. In the world of equity investing, especially with growth companies, the concept of profit gets slippery. “If a company is increasing its sales dramatically, and operates in a slow paying industry, such as healthcare, they could be cash flow negative the whole year. More often than not, companies go out of business not because they lack profitability, but because they run out of cash.”
If thatzzs the case, what good are profits? The point precisely, and the reason that, Ligeti, like most other equity investors, have a decided preference for the cash flow statement.
Still there are a few items he looks for on the income statement. First, like a banker, hezzs going to look at gross, operating and net margins to see if they are in line with industry averages. And hezzs going to look at the trends in contributions to revenues, if the company has more than one product or line. “Ideally, wezzd like to see the revenues moving toward the higher margin products over time.”
Also, hezzll be looking at whether or not the revenues are recurring, meaning is there a lot of repeat business, or does the company have to find new customers all the time? “Obviously, itzzs much less expensive to generate revenues from existing customers than it is to go out and find new ones,” says Ligeti. “If the revenue structure is a recurring one, the company can substantially increase its earnings over a period of time.”
Next he looks at the general and administrative expenses. Though high general and administrative expenses are not viewed favorably, perhaps they are high because the owner wants to break even rather than show a profit. Many business owners engage in this management of income to reduce or avoid paying corporate income taxes. Then again, maybe expenses are high because the owner is not on top of the company
Next, if he didnzzt see R&D on the balance sheet in the form of capitalized expenditures, hezzll be looking for some R&D expenses on the income statement. This only applies to technology companies, where innovation is the key to future profits. For most service or manufacturing companies, a commitment to R&D does not matter to equity investors.
In addition to the value of expenses, Ligeti says most equity investors will also look at the trend relative to revenues. “Theyzzre looking for operating leverage,” he says. “Ideally, the company is engaged in a business where general and administrative expenses, as a percentage of sales, decrease as sales increase.” Thatzzs a significant benefit, since under those conditions, the company becomes more profitable, hence more valuable, the larger it gets.
Cash flow Analysis for the Equity Investor
That would be a first cut at the income statement. For a closer look, Ligeti, like most equity investors is going to analyze the cash flow statement. “Overall, I want to see how capital intensive the business is,” says Ligeti, by which he is referring to financial capital as well as plant and equipment.
Therezzs nothing wrong with capital intensity per se. Itzzs just that if the business needs a lot of money to grow, the equity investor must know this up front. Seasonality, for instance leads to capital intensity because a company must bulk up on inventory, and endures carrying costs.
Hezzs also checking out the rate at which accounts receivable turnover. Remember accounts receivable eat cash. And the longer a receivable is outstanding, the more cash it eats. For growth companies, lengthy collection periods, in conjunction with an overall increases in the volume of receivable means that the company is really getting squeezed. In fact, says Ligeti, itzzs possible for a growth company to be highly profitable, but cash flow negative every month.
Though receivables financing from banks would seem to solve capital intensity issues, itzzs not always available. For instance companies that are very young often cannot get receivables financing. Also, companies which have new or untested products also have a tough time landing receivables financing. And services receivables always cause problems because there is no exchange of a physical product, and therefore nothing the seller can take back if the buyer fails to pay. At the end of the day, itzzs the often equity investor who has to step up to the plate, and provide the extra layer of capital, so that the operation can catch its breath. But the question in his or her mind says Ligeti is “Just how much capital is this going to take?”
The answer to this question requires more than just an analysis of whatzzs happening with various balance sheet accounts, and how they effect cash. There are also things like the principal portion of loan payments, and capitalized lease obligations (i.e., where you own the equipment when the lease is over) that never show up on an income statement, but nonetheless are vital, and often requires voluminous outlays for any company that is ramping up for the future. Ergo, the preference for the cash flow statement over the income statement for most equity investors.
INFO BOX
Taking Action: Analyze your own financial statements like the above investors do, and see what it tells you about the strengths and weaknesses of your own business. Youzzll need to address these weaknesses in your presentation to investors, and how, once the company is funded, they can be remedied.
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