Why Is Your Balance Sheet So Important To A Bank?
Written by CMG News Contributor, Doug Carleton
Do banks care whether or not you are making a profit? You may be making a profit but still skating on edge because of how you financed the assets that have created your growth. The balance sheet shows the assets that allow the company to operate and grow, how the company financed them, and how much money you have invested or reinvested in your company. It is an immediate snapshot of your company's financial strength at a particular moment. How the company financed the assets is important because if the company has most of its assets financed by debt, any change in performance could cause you to liquidate. Your company could then be essentially insolvent if there is more debt than your assets' liquidated value. Suppose there is a lot of debt on the balance sheet. In that case, payments on that debt could be eating up much of the company's cash flow, possibly putting the company in jeopardy of not being able to service the deficit in the event of a business or economic slowdown.
In the Owner's Equity section of the balance sheet, one number pays particular attention to the original investment, any additional capital invested, and any net income is Retained Earnings. What that tells a banker is whether or not an owner is leaving any company profits to reinvest in continued growth. If you (the owner) take most of the company's profits each year, leaving very little to strengthen its finances continually, the Retained Earnings number will change very little year-to-year. That sends a negative message to a banker that the owner is not reinvesting.
The economy is on its way to a substantial recovery. The Federal Reserve voted last week to keep interest rates near zero for the foreseeable future. Opportunities for financing future business growth for small businesses have not been this good for a long time. A strong balance sheet will be one of the things that can improve your chances of obtaining financing if you decide to pursue it.
This blog entry is a slightly edited excerpt from Doug Carleton's 'The Daily Life Of A Small Business Owner' series. Doug was a mentor with SCORE, Startup Virginia, and Lighthouse Labs, and has 25+ years of experience in small business finance including 12 years in SBA lending. To contact Doug directly, please email him at email@example.com.