Before banks grant you a loan, they consider a business’s financial aspects, including financial statements. The balance sheets, income statements, and cash flow statements are major documents to be reviewed by the bank because they are liable to safeguard their shareholders’ capital and comply with regulations. They also need to prepare for the worst as the borrower might go bankrupt, making the loan recovery difficult.
An income statement breaks down the sales and expenses of a company into all its components and highlights the net profit. By carefully analyzing the income statement, banks determine the expenses for making a certain product or service, including direct and indirect expenses. Before extending credit, financial experts hired by banks go through the income statements to find out if a firm invests in premium products with low volume or indulges in high-volume sales at a discounted price.
All this information is necessary to determine if the business under scrutiny is sustainable over a long period or if it is just another hopeful venture that falls into oblivion, like many others.
Cash Flow Statement
For a banker, it is valuable to assemble creditworthiness data from balance sheets and income statements.
However, the eventual goal is to measure the borrower’s cash flows. By reviewing liquidity arrangements, the bank ensures that the company has a steady influx of cash and is eligible to extend credit. A cash flow statement explains a company’s liquidity movements in operating, investing, and financing activities.
The flux of cash, whether in or out, can be because of past actions by the company. Therefore, cash flow is carefully analyzed by the bank. If there is any loan that was taken previously, it will show in the cash flow. The bank’s goal is to see if you have enough cash resources to run the business and pay off the loans simultaneously. Banks like extending credit to clients that have a positive cash flow statement because, to run their business, they require people and businesses that need a loan. So, it ultimately serves their interest as well.
The company’s balance sheet shows what it owns and owes in the form of liabilities.
A company’s assets, including land, machinery, cash, and other intangible assets, are analyzed to judge the worth of a business. Any loans and accounts payable fall under liabilities that need to be paid off by the company. Information about equity and stockholders is also included in the balance sheet, and before extending credit, banks go through that information to find the liable parties in case of nonpayment.
Also, the business assets are the first items the bank must dispose of if the business fails to repay the loan. A balance sheet offers a detailed business description and is the most vital source of information used by banks and other stakeholders.
Other Considerations Before Extending Credit
Most of the information about a company will come from the above statements. However, some details remain hidden from these reports and are sought after by the bank. For example, if a company has been involved in a lawsuit or any other judicial proceeding, the information will not be present in the statements. To tackle that, banks extensively research the company operations and sometimes even conduct interviews with management and employees to understand the situation better.
In short, banks take all possible measures before extending credit to ensure its full repayment with interest.
In conclusion, the meticulous scrutiny of financial statements—income, cash flow, and balance sheets—underscores a bank’s commitment to assessing the creditworthiness of businesses. Beyond these documents, banks delve into undisclosed aspects, such as legal proceedings, through thorough research and interviews. The gravity of extending credit lies in safeguarding shareholders’ interests, complying with regulations, and preparing for potential loan recovery challenges. In this intricate process, banks aim to ensure the sustainability and reliability of businesses seeking credit, emphasizing the importance of comprehensive evaluation for successful loan outcomes.About Complete Controller® – America’s Bookkeeping Experts Complete Controller is the Nation’s Leader in virtual bookkeeping, providing service to businesses and households alike. Utilizing Complete Controller’s technology, clients gain access to a cloud platform where their QuickBooks™️ file, critical financial documents, and back-office tools are hosted in an efficient SSO environment. Complete Controller’s team of certified US-based accounting professionals provide bookkeeping, record storage, performance reporting, and controller services including training, cash-flow management, budgeting and forecasting, process and controls advisement, and bill-pay. With flat-rate service plans, Complete Controller is the most cost-effective expert accounting solution for business, family-office, trusts, and households of any size or complexity.