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So you’ve been making the rounds with potential investors. The road show is going well and there are meetings lined up that could become a turning point in your company. You already know what the investors are going to ask for — the financial statements. The situation then goes one of two ways:either you’re comfortable, confident and know that the financial statements accurately and completely represent your company … or you’re just not sure and hope that a cursory view is all that’s needed.
In business, true confidence comes from a place of thorough preparation. If you want to be sure that what you’re presenting to investors proves the viability of your product or service, the first step is to understand what they’re going to ask for.
Here’s an overview of what to expect.
If financial statements are a book, then these are the most important chapters.
Think of the financial statements as a story, except instead of an ending there is a prediction as to what the likely outcome will be. What story the investors read depends on what’s in the financials.
And since we’re thinking in terms of a story, these are the five main chapters:
Net profit
Sales
Margins
Cash flow
Debt
Net profit is all about whether the company is making money, but there’s more to it. Too much or too little profit are both red flags. It’s OK to show some losses if the path to profitability is clear with scaling up. On the other hand, consistently high profits can indicate unsustainable growth and financial mismanagement. Investors want to know that the product or service is financially sound and there’s money to be made ... but also that management understands how to use it.
The sales number should show that there’s a viable target market for the product or service and that people want to buy it. The best sales figures will demonstrate a consistent upward trend so there’s no guessing what might happen. Of course, this isn’t possible for a company that hasn’t yet taken a product to market. In that case, look to data from focus groups, prototype feedback and/or extensive research to back up the claim that this product is worth investing in.
Margins are another way to prove that executives understand how to use money and manage financials. Expect investors to look at the overall profit margin and product- or segment-level profit margins. Don’t worry if the margins aren’t fantastic; simply understand why, have a plan to fix them and explain the reasoning. And like net profit, sustainability is key.
Next, does the company have enough cash on hand to meet current obligations? Cash flow
management can often be the difference between a company that lasts and one that falters during a down economy. For one, it’s a buffer if customers take longer to pay than usual or there’s a significant economic disruption – like COVID-19. And investors won’t have to worry that the only thing keeping the company afloat is their money.
Finally, debt. Debt does get a bad reputation and it’s not necessarily bad; after all, it’s important to establish a line of credit for several reasons. But too much debt is a red flag because investors see their profits go out the window to principal and interest payments. It’s a concern if the company goes under and investors are left with the bill. If the company has a lot of debt on the books, investors may want to see a plan to pay it down before they sign on the dotted line.
Also, be prepared to show that owner equity is part of the story. Investors are often wary of potential investments if the owner and/or co-founders haven’t put their own money on the line, too. Personal investment, not just sweat equity, matters too.
And every story relies on well-developed characters, like these.
Within each of those chapters, there are key performance indicators that help to shape the narrative. The following KPIs need to be clearly identified for investors to get the best understanding of how the company is doing now and what is likely to happen down the road.
Customer acquisition cost
Customer churn rate
Accounts receivable turnover
Breakeven point
Investors want to know that the company knows how much it costs to get a customer, on average. Though this is a metric, what the customer acquisition cost really details is the process behind what it takes to land a new customer. This metric is also an indicator of how receptive people are to buying the product or service. Usually, customer acquisition cost can be lowered through repeat customers and referrals as well as achieving economies of scale.
The customer churn rate indicates whether the company can keep the customer it just brought in. A low number means loyal customers and can help to offset a higher acquisition cost. Conversely, a high churn rate means something is wrong with the customer retention process and represents a bigger investment risk.
Accounts receivable turnover can also identify whether an investment is risky or not. Generally, the longer it takes for invoices to get paid, the worse off the cash flow tends to be. Investors want to see an A/R turnover that’s low in days aging and write-offs and high in collections.
Last but not least, the breakeven point is the path to profitability. It’s the target date by which the effort is paid off and the company will turn a profit. For start-ups with losses, this is usually achieved by economies of scale and – ahem – investments, so be able to prove it and back up the target date assumption.
Do you know how to write the financial story?
To get to the point that all this information is compiled, reviewed and readily available, it takes a dedicated accounting team to make it happen. Worthwhile investors need to know that the company and its management have a viable product or service, a path to success and a plan to stay there. Though the financial statements may seem like a perfunctory compliance obligation, they’re so much more.
If starting from scratch, it can take several weeks to get this level of financial detail ready for review. Best practices are to stay on top of financials in real-time using automated tools and work with an on-demand team. As you perfect the story around your product or service, rely on an outsourced accountant to help you tell your financials’ story.