12 Understanding the Numbers
- Of the total sources of cash, how much is being internally generated by
operations versus obtained from outside sources? Normally wise busi-
nesses rely more on internally generated cash for growth than on external
financing. - Of the outside financing, how much is derived from equity investors and
how much is borrowed? Normally, a business should rely more on equity
than debt financing. - What kind of assets is the company acquiring with the cash being ex-
pended? Are these asset expenditures likely to be profitable? How long
will it take for these assets to repay their cost and then to earn a reason-
able return?
Kim ref lected carefully on these issues and then finalized her recommen-
dation, which was to approve the loan. The bank’s loan committee accepted
Kim’s recommendation and even went further. They authorized Kim to tell Pat
that—if she met all her responsibilities in regard to the loan throughout the
year—the bank would renew the loan at the end of the year and even increase
the amount. Kim called Pat with the good news. Their conversation included
the following dialogue:
Kim:To renew the loan, the bank will ask you for new projected financial
statements for the subsequent year. Also, the loan agreement will require
you to submit financial statements for the year just past—that is, not pro-
jected but actual financial statements. The bank will require that these ac-
tual financial statements be reviewed by an independent CPA before you
submit them.
Pat: Let me be sure I understand: Projected financial statements are for ward-
looking, whereas actual financial statements are backward looking, is that
correct?
Kim:Yes, that’s right.
Pat: Next, what is an independent CPA?
Kim:As you probably know, a CPA is a certified public accountant, a profes-
sional trained in finance and accounting and licensed by the state. Indepen-
dentmeans a CPA who is not an employee of yours or a relative. It means
someone in public practice in a CPA firm, someone who will likely make an
objective and unbiased evaluation of your financial statements.
Pat: And what does reviewedmean?
Kim:Good question. CPAs offer three levels of service relating to financial
statements:
- An auditis a thorough, in-depth examination of the financial statements
and test of the supporting records. The result is an audit report, which
states whether the financial statements are free of material misstate-
ments (whether caused by error or fraud). A “clean” audit report pro-
vides assurance that the financial statements are free of material
misstatements. A “modified” report gives no such assurance and is cause