What Your Banker Looks For in Your Financial Statements

Bruce Brandford, Regional CEO of Sterling Bank's North Texas Region shares his thoughts.

Recently, I enjoyed the opportunity to share, from a banker's perspective, what I am focused on in reviewing a client's financial statements. The questions from the group of about ten entrepreneurs helped me understand that for many, this is an area that is not well explained by the banking community. First off, from a process standpoint, most banks take a client's financial statements and put the information into a common format by way of a financial spreadsheet program. This assures the user of the resulting data that the numbers balance (or, on rare occasions that they don't), and that the information is presented in a consistent manner both across a span of time and across the dataset of all companies. By formatting the data in this fashion it is somewhat easier for your banker to quickly review the data and begin to make some conclusions as to the health and challenges a particular company may face.

I prefer to start with the income statement, first considering the bottom line profit (or loss), the gross margin and net margin, sales volumes and the trends in each of those categories. That quick glimpse will begin to help me understand the company's relative direction (growing, contracting, struggling, or thriving).

I follow the income statement with a look at the balance sheet. It is here that I can begin to develop a feeling about the company's ability to take advantage of opportunities, or to weather a financial storm. Again, directional understanding is important, and key measures to be considered (which will vary by industry) include liquidity, the relative level of accounts receivable and of inventory, equipment, real estate and, very importantly, the balance between debt and equity.

Coupling the balance sheet with the income statement, an analysis can be made of the relative level (usually measured in days sales outstanding) of A/R, inventory, and payables, plus arithmetic measures of liquidity (current ratio, quick ratio), the relative efficiency of the company's returns on assets and on the shareholder's equity as well as other important measures.

Finally, financial analysis programs also provide very important data regarding the company's cash flow. In the world of banking it is cash flow that is the number one source of repayment, so careful analysis of the cash flow, its strength and volatility, will all play a large role in the banker's full understanding of the company's historical (and prospective) ability to pay the bank back.

Comparative data is useful in determining how the subject company's financial results measure up against similarly sized companies with the same SIC codes. There are national databases that aggregate financial data from multiple sources which is then put into a standard format for this type of comparison.

Next time you meet with your banker, I suggest you share your company's financial spreads and comparative data. Ask what he or she is looking for in your financial results, and to share perceptions of the areas where you are excelling and those that may be of some concern. That conversation will likely evolve to consider the "what ifs" related to your plans for the company. Does your existing financial condition position you for continued growth and the possible need for additional debt capital to do so, or should you instead be focused on pruning your operations to make your way through the storm? In today's marketplace, more than ever before, it is important that you understand how your bank views your circumstances.

Definitions of terms:

Income Statement - also called the profit and loss statement (P&L) and Statement of Operations, is a company's financial statement that indicates how the revenue (money received from the sale of products and services before expenses) is taken out.

Balance Sheet - or statement of financial position is a summary of a person's or organization's balances. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year.

Current Ratio - the ratio of current assets to current liabilities. The current ratio is calculated by dividing current assets by current liabilities. Current assets at least twice current liabilities (ie, a current ratio of 2.0) is considered a healthy condition for most businesses.

Quick Ratio - computed as quick assets (cash, marketable securities, and receivables) divided by current liabilities. A measure of short-term debt-paying ability.

Shareholders Equity - often referred to as the book value of the company, and is the money that was originally invested in the company, along with any additional investments made thereafter.

Cash Flow - a revenue or expense stream that changes a cash account over a given period. Cash inflows usually arise from one of three activities - financing, operations or investing.

NAICS (formerly SIC) code - a business classification system developed through a partnership between the United States, Canada and Mexico.