The previous articles
We’ve explained in the previous article that there are six factors that may give you an idea about the profit likelihood of investing in an already existing business, whether by partial purchase, by fundraising, or even by total purchase in some cases. These factors are the executive and financial managers of the business, the business model, the financial statements, the certified public accountant of the company, the legal papers of the business, and partnership guarantees. In the previous two articles, we have talked about the importance of knowing the background and competence of the business managers and their transparency. We’ve also learned about the importance of the business model. Now comes the turn of financial statements.
Financial Statements
Despite the importance of financial statements, many small and medium-sized companies (and some large companies, unfortunately) do not have accurate financial statements, or, sometimes, they do not have them at all. In an unprofessional work environment, financial statements are prepared poorly and for purposes other than those for which they should be actually prepared.
The importance of financial statements is that they give you a detailed vision of the company's financial situation. They also provide you with a vision of its future. Moreover, having accurate financial statements is necessary to deal with taxes, investors, and government agencies.
What are financial statements?
Financial statements are a set of annual reports, which are also preferably to be prepared quarterly. They include the total values of the company's current and non-current assets, and its short-term and long-term liabilities. Financial statements also include the company's total revenues, its total expenses, its net profit, the taxes due on it and how cash flows into and out from the company.
Components of financial statements:
Financial statements consist of 4 main statements, in addition to the details and explanations of these main statements. The statements are:
1. Balance sheet
The balance sheet includes the company's total current and non-current assets. It also includes its short-term and long-term liabilities, as well as shareholders' equity.
2. Income statement
The income statement includes the company's total revenues, the total cost of getting those revenues, its operational expenses, due interest, depreciation values for assets, and any other allowances. The main purpose of this statement is to determine the net profit or loss of the company.
3. Cash-flow statement
Through successive balance sheets, cash flow statements can be calculated, which are statements that express the flow of cash into and out of the company. While the income statement may show high profitability, cash flow statements give a picture of the company’s ability to manage cash. The company may default on paying dues despite achieving profits. The opposite could be true as well, as net income may be negative in the income statement (i.e. Loss) while the company is able, up to a certain extent, to pay its future liabilities, thanks to borrowing, new investments, selling assets or otherwise.
4. Statement of changes in equity
This statement shows changes in shareholders' shares during a certain period, such as a capital increase or dividends distribution.
A company may not have financial statements in a professional, organized manner. In this case, before investing in any business, you should require the business owner or his managers to prepare financial statements that are to be reviewed and audited by the independent auditor or the certified public accountant. This is not considered arbitrariness, as it is the most basic of the investor’s rights, for the benefit of the investor and for the benefit of the business in the first place.