Guest Author: Shagun Malhotra, Founder of SkyStem LLC
An area on the financial side of startup growth that is often left by the wayside is the balance sheet. And this can cause significant problems for startups if they don’t address it. Most banks and other financial institutions require at least three years of projected financial statements to grant loans or participate in a capital raise. On top of that, a bank will almost certainly require a copy of a balance sheet when assessing your financial risk, so you can say goodbye to the idea of securing a loan or investment if you don’t have your balance sheet in play.
This crucial financial statement, while it can seem a bit daunting and complex, reflects the financial health of your business. Let’s take a look at what a balance sheet is and why it holds for startups.
The Blueprint for a Strong Balance Sheet
A balance sheet is made up of three key facets—assets, liabilities, and equity—and gives you an idea of your financial health and stability within a specific time period. Startups that have a good understanding of their balance sheet will be able to improve their financial position, make data-driven decisions, and take the necessary steps to secure funding from lenders and investors.
Put simply, assets are things that your company owns that will bring about future benefits, such as cash and inventory. Liabilities refer to your company’s debts, which could include short-term obligations and taxes. And finally, equity is your company’s value from what you own after subtracting debts. It’s absolutely vital that the sum of liabilities and equity matches the total assets, ensuring that there is…well…balance in your balance sheet.
A balance sheet essentially can be boiled down to two sides, current and long-term assets and liabilities. Current assets and liabilities are short-term funds and debts, like inventory and immediate payments, showing liquidity. Long-term assets and liabilities, such as real estate for example, take more time to convert to cash and include debts that may have accrued over a longer time, such as bank loans or bonds.
The difficulty with startups is that, in many cases, metrics are going to be tricky to track if you’re in the very early stages. In some cases, it might be worth tracking the startup’s progress by converting hypotheses into facts, instead of judging whether a plan has been executed properly.
What Are Some of The Benefits of a Well-made Balance Sheet?
Firstly, startups will unfortunately often face periods where they have negative cash flow, which could likely result from investing heavily in their growth and potential product development. Obviously, large corporations have the luxury of positive cash flow with well-established revenue streams, but startups need to be much more conscientious, so staying on top of the situation with a balance sheet while coping with limited financial resources is crucial. As we discussed in the intro, investors will be keen to understand your financial health before giving you funds. You need to demonstrate that you are fiscally responsible.
Your balance sheet will also help you plan out where you can allocate your resources properly so you can make good strategic decisions. It’s a given that there is also an inherent risk in running a startup, from market volatility to operational challenges, looking for sustainable growth. However, ensuring there is sufficient liquidity and manageable debt levels with a complete balance sheet will help a lot.
Having accurate records in the form of balance sheets is also important when the taxman comes calling. The IRS explicitly recommends that startups prepare tax returns earlier than other businesses. Having a balance sheet in order will help an accountant and also prevent any unforeseen difficulties in the event of an IRS audit. There are countless examples of startups not complying with income tax laws and being punished. Just recently, several notices were issued to some startups in the fintech sector for missed payments under Section 68 of the Income Tax Act.
Last Call for Your Balance Sheet
The balance sheet clearly stands as a cornerstone of financial health for all startups. As we have discussed, it is far too often overlooked but crucial for sustainable growth. The vital components (assets, liability, and equity) all need to be assessed and reconciled. This will help you to paint a picture of your financial standing and guide future decision-making to give you the best shot securing investor trust.
With the huge challenges of negative cash flows and limited resources, startups need to prioritize maintaining a balance sheet. It serves both as a roadmap for resource allocation and strategic planning and safeguards against potential tax liabilities, ensuring compliance and financial stability. If startups can understand a balance sheet’s importance and recognize its role in sustainable growth, they can feel more secure when navigating the entrepreneurial journey.