Raising funds is an important part of a startup’s journey. However, in order to effectively fundraise, you must get your company’s financials in order so that potential investors can get a good overview of the company and digest the information quickly and easily.
Besides looking at the basic information of a company’s product and business model, the potential investors will delve into historical financial statements to gauge your savviness as an entrepreneur, the level of your understanding and commitment to your business.
Reason why many startups fail to impress investors is because they are unable to produce financial evidence to back up their potential. Financial statement analysis comes in to help the cause with all financial data about a startup that is required by the investors for decision making.
What is financial statement analysis?
Financial statements of a business reflect its health, performance, and current position. Analysis of financial statements provides a deep insight into a startup’s financial situations and helps investors evaluate the fundamentals and current economic status of the company and predict its future course.
Financial statements analysis entails methods used in assessing and interpreting the results of past performance and current financial position of a startup to help investors with forecasting and investment decisions.
What are the different types of financial statements?
Financial statements typically includes the following:
- Balance sheet
- Income statement
- Cash flow statement
- Supplementary notes
Also, there can be internal and external analyses of financial statements. Internal analysis is conducted by employees, executives, government agencies and others who have access to a company’s internal accounting records.
An external analysis, on the other hand, is carried out by outsiders who have access to publicly available financial statements. Creditors, investors, credit agencies, government agencies, and the general public are examples of outsiders.
How to evaluate the financial performance of a company?
The financial statements analysis can reveal different facets of the financial status of a company and provides useful data to the management, creditors, and investors to help make informed decisions. Given below are some of the major benefits of financial analysis.
#1 How was the past performance and current position of the startup?
Past performance in most cases is a good predictor of future results, which is why a potential creditor or investor becomes interested in past sales trends, expenses, net income, cash flow, and return on investment. These trends can be used to evaluate management’s past performance and can also be used to predict future performance.
Similarly, a current position analysis shows where the company is right now. For example, a current position analysis will show the various assets owned by a business enterprise as well as the various liabilities owed to the business. It will reveal the company’s cash position, the amount of debt it has in relation to equity, and the reasonableness of inventories and receivables.
#2 What will be the net income and growth predictions?
Financial analysis of a company also gives a probable picture of earnings prospects and growth rates, which are used by investors when comparing investment options by assessing the earning potential of businesses. The risk or uncertainty associated with the expected return is also evaluated by investors.
The decision-makers are futurists who are constantly thinking about the future. Financial statements containing information on past performance are analysed and interpreted to forecast future rates of return and assess risk.
#3 Is the company loan worthy?
Financial institutions, lending agencies, banks, and others use financial statement analysis to make sound loan or credit decisions. Empirical studies conducted in the field of accounting and finance suggest a set of financial ratios as given below, that can evaluate correctly if a startup is loan worthy.
- Activity ratios – measures the quality of the management and its performance.
- Leverage ratios – measures the startup’s dependability on debt for the operation.
- Profitability ratios – measures the startup’s profitability quotient.
- Liquidity ratios – measure the startup’s ability and capacity to remain in business.
The above ratio models yielded by the financial statement analysis aids in determining credit risk, as well as the terms and conditions of a loan, such as interest rate and maturity date, if one is granted.
#4 What is the chance of bankruptcy and closing down of the startup?
Financial analysis reports play vital roles in predicting the likelihood of a company’s bankruptcy and failure. The ratio models mentioned above provide an early warning of a company’s failure.
Managers, investors, and creditors can all benefit from such prediction models based on financial statement analysis. Managers can use the ratios prediction model to assess their firm’s solvency position and take preventative measures to avoid or minimise losses once they are aware of the likelihood of failure. To reduce the length of time losses, corporate management can change operating policies, reorganise financial structures, or even go into voluntary liquidation.
Similarly, investors, shareholders, and creditors can make more informed decisions about investing in the company or its creditworthiness.
Driving for quick and sustainable growth is in the DNA of the startups. Accurate and regular financial analysis of the company is of foremost need to remain on the right track and direction on one hand and convince the investors for funds on the other.