What is your balance sheet going to look like next year? The year after? What about three years from now? Do you care? Many times the answers to these questions are: not sure, no idea, don’t know and yes I care but I don’t have the information to properly answer these questions. It’s very typical for a small or medium sized business to not know what their financial statements are projected to look like over the coming year much less the next three years. Many times they will have a budget (that is usually inconsistent with their historical performance) but haven’t done the work to take the budget one step further and have it flow into an actual set of pro forma financial statements.
What are pro forma financial statements and why do they matter?
Do you know what your business owns and owes? Do you know what your business makes and spends? More importantly – do you know what the equity is in your business or what it might be worth? It’s typical for an entrepreneur or for someone running a business to say “yes I know what we make and spend” but unlikely that they know what they own/owe and what the equity in their business is or what the value might be. Small and medium sized businesses can be so focused on surviving that they often don’t take time to see if the needle is moving in the right direction with respect to the equity or value of their business. This is unfortunate because one of the very reason businesses are started is to build value and one day be able to cash in or have that value recognized.
So where is the best place to start if you can relate to this?
As much as I enjoy working with small businesses, one of the points of friction when discussing business loans (or commercial mortgages in some cases) is the matter of pro forma financial statements. As I have written in the past, most businesses run their business plan from their profit and loss statement. A profit and loss statement shows revenue less expenses to equal what’s left over in the form of net income. Many small businesses don’t bother looking at their balance sheet which shows them the other side of the ledger – what their business owns versus what their business owes. A prudent business owner will look at their profit and loss in addition to their balance sheet on a regular basis to measure the performance of the business and some even go further to project what they think their balance sheet and income statement will look like over the next few years. These are referred to as “pro forma” financial statements.
Need: mortgage to purchase a commercial property
Challenge: no financial statements to show business history
To obtain financing for the purchase of a real estate property, most banks want to see that the company can make the monthly mortgage payments. The math formula used by lenders to determine how much to lend a company is based on a range of $1.10 to $1.25 of income for every $1.00 of debt. The bank wants to know that there is more than enough income available to ensure the mortgage payments are made. A two year (or more) average will be used by examining the financial statements of the business to get an idea of what the business can afford. New businesses who do not have the financial history need to present their transaction in a different way to the bank. Using a mortgage broker who understands the market and the requirement of the banks can help your business structure its transaction. A good broker will help you present your application to a bank to address all of their concerns – even if you are a new business. If you would like to speak with us about your deal, email email@example.com or visit www.bridgecap.ca/dylan.