How to Financially Study a Small Business

When considering the financial health of a small business, the process is similar to that of studying a large corporation. However, there are unique challenges and strategies to ensure a thorough examination.

Understanding the Financial Landscape

Much like large businesses, small businesses rely on financial statements to gauge their financial health. These include income statements, balance sheets, and cash flow statements. However, accessing these documents can be tricky, and they are often guarded closely by business owners, especially when it comes to sensitive financial data.

Accessing Financial Statements

First and foremost, gaining access to financial statements requires permission from the business owner. This may not always be forthcoming, and business owners are accustomed to guarding this information like precious gold. Financial statements are often protected, and companies, unless publicly traded, have no standard policy requiring their disclosure to the public.

Even if you are given access, you may have limited information. Some small businesses utilize a Certified Public Accountant (CPA) who provides a compilation or a "limited review." This can be reassuring, as these reviews often provide enough detail to analyze both income and balance sheets.

Alternative Methods of Financial Analysis

When direct access to financial statements is unavailable, there are several other methods to perform a financial analysis:

Reviewing Tax Returns

Tax returns offer a wealth of information, and they can be a reliable source of data. The tax information can reveal various aspects of the business's financial performance, including income, expenses, and tax liabilities. However, there are a few key points to keep in mind:

Many small businesses operate on a cash basis, meaning they only report income once it is received and expenses once they are paid. This can lead to discrepancies when trying to assess the business's true financial position.

Beware of unpaid expenses. While these may not show up in every transaction, reviewing the first few months' disbursements can give you a good idea of any outstanding payments.

By carefully examining the first few months of disbursements, you can get a sense of any potentially unpaid expenses, which can be crucial in understanding the overall financial situation.

Conclusion

Financially studying a small business can be a challenging process, but with the right approach, it is possible to gain a comprehensive understanding of its financial health. From accessing financial statements to reviewing tax returns, there are multiple avenues to explore. Understanding the unique challenges and employing effective strategies can help you make informed decisions about the business's financial stability.

By focusing on key financial metrics and conducting thorough research, you can effectively gauge the financial performance and position of a small business.