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Why financial reporting is a must to raise capital

       
  • Analysis & Reporting
  • Thought Leadership

Why financial reporting is a must to raise capital

Why financial reporting is a must to raise capital

Are you a young and fast-growing organisation looking to expand your business by raising capital? If so, financial reporting is an important cornerstone component of making that happen.

It's essential to provide reliable information for potential investors to make informed decisions about investing their money in your venture. While it can seem daunting initially, the good news is that technology has made it easier.

By leveraging cloud-based reporting solutions integrated with Excel's functions, businesses can produce detailed, accurate reports quickly and efficiently. Read on as we discuss how financial reporting can help to raise capital.

 

Garners investor trust and confidence

Ask yourself, how many times have you lent money to a stranger? We all know the answer.
We do not lend money to anyone simply because of the lack of TRUST. Trust is the bedrock for successful relations between investors and companies. 

“Virtually every commercial transaction has within itself an element of trust, certainly any transaction conducted over a period of time.” 
-Nobel Laureate Kenneth Arrow

This is very much true for raising capital, too. This is where financial reporting plays a crucial role. Financial reporting is crucial for investors to assess company performance and anticipate future returns. 

However, it extends beyond mere numbers and graphs. It cultivates transparency and accountability, fostering trust and confidence among investors.

Accurate and comprehensive financial reports provide a transparent view of a company's financial well-being, which is important for potential investors and lenders to evaluate its stability. 

These reports disclose key information like revenue patterns, profitability, cash flow status, the company's asset-to-liability ratio, and other vital indicators of its investment potential.

By consistently demonstrating fiscal responsibility and transparency through reliable financial reporting, businesses can establish investor confidence, thereby enhancing their prospects of securing the necessary funds for expansion and growth.

Conversely, poor financial reporting can severely damage venture capitalists' investment prospects.

Incomplete, inaccurate, or misleading financial reports can erode investor trust and confidence, often leading to a reluctance to invest. Investors may perceive the investment as high-risk without a clear, transparent view of the company's financial health.
 

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It is evident from the above image that finance leaders give high importance to financial reporting. As per the BPM Partners 2023 BPM Pulse Survey, finance leaders have given second most importance to financial reporting.

Hence, maintaining rigorous standards in financial reporting is beneficial and essential for businesses seeking to raise capital.

 

Good reporting helps to build higher leverage

Among the various kinds of capital, debt capital is a key component which provides great leverage for the company. Organisations would like to have the right balance of debt and equity in their capital structure to bring the best gains for their shareholders.

To provide debt capital to any organisation, debt investors need financial reports to gauge their risk and evaluate a company's creditworthiness. This is a crucial determinant in shaping the terms of loans.

80% of SME loan applications are rejected due to insufficient financial reporting: Federal Reserve Board

What do they look for in the financial reports? They look at the relevant accounting ratios derived from the statement of income and the statement of assets and liabilities. 

Investors look at the balance sheet to identify its financial stability and solvency. The debt-equity ratio derived from here measures the proportion of debt financing compared to equity financing. A lower ratio indicates stronger financial stability and less risk for investors.

The income statement shows the company's profitability by detailing its revenue, expenses, and net income, indicating its ability to generate income and repay loans. This is measured by the debt service coverage ratio that shows a company's ability to meet its debt obligations by comparing its earnings before interest and taxes (EBIT) to interest expenses. A higher ratio indicates a stronger capacity to repay loans, a positive sign for investors.

The cash flow statement helps investors track the company's inflow and outflow of cash, revealing its liquidity and ability to meet short-term obligations like loan payments. Here, investors look at the current ratio that measures a company's ability to meet its short-term obligations by comparing its current assets to current liabilities. A higher ratio indicates greater liquidity and less risk of default.

These insights from the financial reports not only help investors decide whether to invest or not but also define the terms of the investment.

 

Enjoy low cost of capital

Companies with strong financial reports and high creditworthiness qualify for lower interest rates, reflecting lower risk for lenders.

In Q3 2021, the average interest rate on SME loans was 5.5% for the most creditworthy firms, compared to 9.6% for those with high credit risk: Federal Reserve.

Investors are more likely to offer larger loans to companies with strong financials, demonstrating their ability to handle larger debt obligations.

It doesn't stop with the interest rate and amount of capital. Companies with strong cash flow may be offered longer repayment periods, allowing them more flexibility.

Also, investors may require less or no collateral from companies with strong financial reports, demonstrating their inherent trustworthiness.

Therefore, accurate financial reporting is vital for businesses seeking loans, as it directly impacts the loan's terms and conditions, ultimately affecting the company's bottom line.

 

Benefit from higher valuations

There are different kinds of equity valuation methods, such as the comparable approach, discounted cash flow method, asset-based valuation, book-value approach, etc. Irrespective of the method, all equity investors rely heavily on the company's financial reports.

Investors can use the revenue growth data to evaluate a company's intrinsic value and compare it with its market value to identify if the stock is undervalued, overpriced or at par. Growing companies that are undervalued draw a higher number of investments and great capital.

Metrics such as debt-equity ratio, cash from operations, net profit growth, etc., are signs the investors look for to evaluate the risk, organisational efficiency and profitability, respectively. Positive signs mean a greater chance of equity investments.

When the financial reports show strong financial performance by demonstrating consistent profitability and positive cash flows, it builds investor confidence and attracts larger capital investments.

Companies with strong financial reporting practices experience 10% higher stock valuations: McKinsey & Company.

Investors also look for qualitative aspects in the financial reports. Companies with clear growth plans and a promising future can attract significant capital from investors seeking high returns. 

Also, the rise in the general awareness of climate change and its impact on business and society has led to an increase in a new category of investors called impact investors. 

By including ESG disclosures in their financial reports, many small companies can attract many impact investors.

88% of impact investors influenced by financial transparency and social/environmental responsibility: Global Impact Investing Network

 

Conclusion

Strong financial reporting is the bedrock for a company's valuation and investor confidence. By prioritising accurate, transparent, and consistent financial reporting, companies can attract more capital, fuel growth, and achieve long-term financial goals.

To build investor trust and confidence to raise new capital, be it equity or debt, the financial reports must be accurate, compliant, and contain the right qualitative and quantitative information to attract investors.
 

JustPerform is a cutting-edge platform that seamlessly integrates with over 80 source systems, enabling accurate and timely financial reporting. The JustPerform Financial Consolidation Pro app simplifies external reporting and regulatory compliance with its built-in IFRS/GAAP-compliant scenarios. Want to level up your financial reporting? Here's how.


Moreover, having clean books and a clear working knowledge of them prepares you to answer tough financial questions from potential investors. This can show that you are prepared and serious about your business, increasing your chances of raising capital.

At the same time, let's remember that a company's stakeholders are not shareholders alone. Accurate financial reports can create value for the company in multiple ways. Therefore, it is essential for companies to maintain the best practices of financial reporting.

In essence, financial reporting acts as a bridge between companies seeking investments and potential investors, facilitating well-informed decision-making and fostering valuable financial partnerships.

Financial reporting builds investor trust and confidence by demonstrating fiscal responsibility and transparency. This enhances prospects for securing necessary funds.

Good financial reporting practices lower borrowing costs like interest rates from investors. It also helps to attract larger investments through higher valuations when performance meets investor criteria like profitability and growth.

Accurate financial reporting builds a foundation for cultivating good relationships with investors. While requiring diligence, platforms like JustPerform now streamline the process through automated solutions. Maintaining rigorous reporting standards becomes as easy as a breeze for small companies seeking investment.

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