An area on the financial side of startup development that is often ignored is the balance sheet. And this might cause serious problems for startups if they do not address it. Most banks and other financial institutions require at least three-year projected financial statements in order to grant a loan or participate in a capital increase. What’s more, the bank will almost actually require a copy of your balance sheet when assessing your financial risk, so you’ll be able to say goodbye to the idea of securing a loan or investment if you do not have a balance sheet in play.
This key financial statement, while it could appear somewhat daunting and complex, reflects the financial health of your organization. Let’s take a look at what a balance sheet is and why it applies to startups.
Blueprint for a strong balance sheet
The balance sheet consists of three key elements – assets, liabilities and equity – and gives an idea of the financial health and stability over a specific period. Startups that have a strong understanding of their balance sheet will have the opportunity to enhance their financial position, make data-driven decisions, and take the needed steps to secure financing from lenders and investors.
Simply put, assets are things your organization owns that may provide future advantages, comparable to money and inventory. Liabilities check with your organization’s debts, which can include short-term liabilities and taxes. Finally, equity is the value of your small business based on what you own, minus debt. It is absolutely essential that total liabilities and equity match total assets, which can ensure… well… balance on the balance sheet.
The balance sheet can principally be reduced to two sides: current and long-term assets and liabilities. Current assets and liabilities are short-term funds and debts, comparable to inventories and immediate payments, that reveal liquidity. Long-term assets and liabilities, comparable to real estate, take longer to convert to money and include debts that will have accrued over a longer time period, comparable to bank loans or bonds.
The problem with startups is that in many cases tracking metrics will probably be difficult if you are in the very early stages. In some cases, it is price tracking the startup’s progress turning hypotheses into facts quite than assessing whether the plan was executed appropriately.
What are the benefits of a well-prepared balance sheet?
First, startups unfortunately often face periods of negative money flow, which can likely be resulting from heavy investments in their growth and potential product development. Of course, large corporations have the luxury of positive money flow and established revenue streams, but startups have to be much more diligent, so staying current with a balance sheet and dealing with limited financial resources is key. As we mentioned in the introduction, investors will need to know your financial health before supplying you with money. You must reveal that you simply are financially responsible.
The balance sheet may also enable you to plan the proper allocation of resources so you can make good strategic decisions. It’s clear that running a startup comes with inherent risks, from market volatility to operational challenges, in the search for sustainable growth. However, ensuring sufficient liquidity and manageable debt levels with a full balance sheet will probably be very helpful.
In the event of a taxman’s visit, it is also necessary to have accurate records in the type of balance sheets. The IRS specifically recommends that startups prepare their tax returns sooner than other businesses. Getting your balance sheet in order will help your accountant and also prevent unexpected difficulties in the event of an IRS audit. There are countless examples of startups failing to comply with income tax regulations and being penalized. Several notices have been sent to some recently fintech startups for missing payments in accordance with Art. 68 of the Income Tax Act.
Last call for your balance sheet
The balance sheet is clearly the cornerstone of the financial health of all startups. As we mentioned, this is too often ignored, but it is crucial for sustainable growth. All material elements (assets, liabilities and equity) require assessment and reconciliation. This will enable you to paint a picture of your financial situation and guide your future decision-making to present you the best likelihood of securing investor confidence.
Faced with the enormous challenges of negative money flow and limited resources, startups must prioritize maintaining their balance sheet. It serves each as a roadmap for resource allocation and strategic planning and as a hedge against potential tax liabilities, ensuring compliance and financial stability. If startups understand the importance of the balance sheet and recognize its role in sustainable development, they will feel safer in their entrepreneurial journey.