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If there’s anything that can be taken away from the FTX fiasco, it's this: due diligence is back.
Responsible investors and lenders will want to clearly understand a SaaS startup's business health and projected growth before offering any capital. This means accurately preparing vital financial statements, such as the balance sheet, income statement, and cash flow statement, is critical for fundraising.
Read on to learn how to prepare financial statements and why they're important for fundraising. We'll also cover using an automated financial tool built for SaaS companies to prepare financial statements.
Types of Financial Statements in an Operating Model
Operating models leverage three core financial statements: the balance sheet (BS), income statement (profit & loss statement), and cash flow statement. These statements paint a comprehensive picture of a business's financial health by summarizing its historical performance (financial activities and position) over a specific period. But their value extends beyond the past. They can also be used to forecast a company's future direction.
The Balance Sheet
The balance sheet is a snapshot of a company’s assets, liabilities, and equity for a given moment in time. This is a useful way for investors to evaluate the health of a business as they can use it to calculate the quick ratio, debt to equity, and other financial indicators.
The key components of a balance sheet include:
- Assets: This shows everything the company owns that has value, such as physical property like inventory or equipment. It also includes intangible things like contracts or licenses. The balance sheet generally splits these between current assets that can be turned into cash within one year and fixed assets that are used over the long term.
- Liabilities: This shows anything the company owes to others, including lenders, employees, suppliers, and even unearned revenue. Like assets, liabilities are typically categorized into current and long-term on the balance sheet.
- Owner’s equity: This is the remaining portion of the company’s value that its founders or investors own. Equity would include the initial investments by the founders, additional capital from outside investors, and any retained earnings the company has generated.
The Income Statement
The income statement (also known as the profit and loss (P&L) statement) shows how much profit or loss the company has generated over a certain period. This includes all revenue and expenses as well as other gains and losses.
One of the biggest challenges with the income statement (or earning statement) is understanding when you need to recognize certain revenue and expenses.
For example, many companies have unearned revenue, which means you’ve received payment before services have been provided. This is a common scenario when SaaS businesses offer annual subscriptions because the revenue is “earned” throughout the year but paid for upfront.
When using the accrual accounting method, unearned revenue isn’t recognized immediately, even if you’ve already received the cash.
The key components of a typical income statement include the following:
- Revenue: This section includes the gross revenue from all sales, which is reduced by discounts, refunds, and other deductions to get net revenue. SaaS companies might have adjustments for certain subscription cancellations or competitor price-matching deals.
- Cost of goods sold (COGS): This is any of the expenses directly related to providing a product or service. For SaaS companies, COGS could include hosting fees, customer support costs, payment processing fees, and more.
- Gross profit (or loss): This is the amount left over after subtracting COGS from net revenue. Similarly, gross margin is the percentage of total revenue that’s left for operating expenses and reinvesting in the business.
- Expenses: This includes cash and non-cash expenses that are not directly related to a product or service. Cash expenses include all the typical expenses a business incurs for its operations. Non-cash are expenses like depreciation and amortization required under accrual accounting.
- Net income (or loss): This is the final profit or loss after all expenses have been deducted. Net income is usually at the very bottom of the income statement, so it’s often referred to as the “bottom line.”
The Cash Flow Statement
The statement of cash flows (or cash flow statement) shows the money flowing in and out of the business for a certain reporting period. Cash inflow and outflows can differ from income and expenses because accrual accounting recognizes economic events when they occur rather than when cash is moved.
This means the cash flow statement acts as a bridge between the balance sheet and the income statement.
A typical cash flow statement includes the following:
- Operating activities: This section includes any cash flows for the normal, day-to-day processes of the business. The primary inflow for SaaS businesses is the receipt of cash from subscriptions or other sales. Outflows typically include the payment of hosting feeds and other operating expenses.
- Investing activities: This section shows cash flows related to company assets. Inflows might include the sale of stocks or other assets. In contrast, outflows include purchasing stocks and other physical or intangible assets.
- Financing activities: This section shows the cash flows related to funding for the company. Inflows include the cash from opening a new loan or issuing new company stock. Outflows include repaying a loan, issuing dividends, or repurchasing company stock.
Closing The Books
When someone refers to “closing the books” in the bookkeeping world, this means transferring the balances in temporary accounts on the income statement to permanent accounts on the balance sheet. Whether you choose to handle bookkeeping yourself or rely on a bookkeeper or accountant, you’ll want to ensure you’re closing out at the end of each accounting period.
Closing the books at the end of each month is crucial for keeping accurate and well-maintained financials that potential investors and lenders can trust. With up-to-date bookkeeping, you’ll also have all your financial data in one place for calculating key metrics about your company’s financial health.
The Importance of Financial Statements During Fundraising
The three primary financial statements provide an enormous amount of information about business health. Here’s why they’re important for fundraising stakeholders.
Why Do Lenders Need Financial Statements?
Lenders will not offer a loan until they are confident that the business can pay its bills. While profitability on the income statement is important, banks will also look for sufficient cash inflows on the cash flow statement and adequate assets as collateral on the balance sheet.
Lenders also usually look at certain ratios like the quick ratio, debt-to-equity, debt-to-assets, and more.
Why Do Shareholders Need Financial Statements?
Potential equity investors or shareholders need financial statements to make informed investment decisions. As with lenders, most equity investors evaluate debt levels and liquidity to determine whether the company can continue to operate successfully. However, equity investors place an even greater emphasis on profitability and the potential return on equity.
SaaS Financials Made Easy With Forecast+
Forecast+ is a financial modeling solution that helps SaaS companies forecast revenue, expenses, and bank balances. This gives you and prospective investors and lenders better visibility into your company's future growth potential.
More specifically, Forecast+ can automatically sync with your income statement and balance sheet from bookkeeping tools like QuickBooks and Xero. It can also automatically generate a cash flow statement based on this data. Then, you can automate your forecasts and allow you to compare them to actual performance.
This seamless approach to preparing financial statements and forecasts is crucial for SaaS startups seeking funding. If you’re ready to simplify your financial statement preparation, start a trial of Forecast+ today!
