Want to know what investors are looking for in the numbers of your financial statements?
Most investors usually look at the income statement first to see whether gross, operating and net income margins are in line with industry averages. If not, it’s a negative. Then again, it doesn’t have to be the kiss of death. Many companies have not reached the critical mass on sales that will reduce the effects of fixed costs, or may be experiencing high costs because they’re growing.
Next most equity investors examine the composition of revenues. They are looking to see if the revenues have gravitated to the higher margin business and will probe the degree to which revenues are recurring in nature. Revenues which occur over and over again without the stimulus and cost of sales promotion are ideal because they increase the company’s overall profitability.
On the expense side ideally there will be operating leverage which means that as the business grows, expenses as a percentage of revenues will level off or go down. The absence of operating leverage does not mean the business will be unattractive to all investors, but it could be a defining characteristic. Some investors shy away from companies that cannot achieve operating leverage.
The balance sheet provides a snapshot of the business’s assets, liabilities and owner’s equity for a given time.
Working capital is one of the most difficult financial concepts to understand for the small-business owner. In fact, the term means a lot of different things to a lot of different people. By definition, working capital is the amount by which current assets exceed current liabilities. However, if you simply run this calculation each period to try to analyze working capital, you won’t accomplish much in figuring out what your working capital needs are and how to meet them.
A useful tool for the small-business owner is the operating cycle. The operating cycle analyzes the accounts receivable, inventory and accounts payable cycles in terms of days. In other words, accounts receivable are analyzed by the average number of days it takes to collect an account. Inventory is analyzed by the average number of days it takes to turn over the sale of a product (from the point it comes in your door to the point it is converted to cash or an account receivable). Accounts payable are analyzed by the average number of days it takes to pay a supplier invoice.
Most businesses need short-term working capital at some point in their operations. For instance, retailers must find working capital to fund seasonal inventory buildup between September and November for Christmas sales. But even a business that is not seasonal occasionally experiences peak months when orders are unusually high. This creates a need for working capital to fund the resulting inventory and accounts receivable buildup.
Some small businesses have enough cash reserves to fund seasonal working capital needs. However, this is very rare for a new business. If your new venture experiences a need for short-term working capital during its first few years of operation, you will have several potential sources of funding. The important thing is to plan ahead. If you get caught off guard, you might miss out on the one big order that could have put your business over the hump.
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