To go from a small to a medium-sized business, companies need to raise a lot of the financing. In this video, explore how reliable financial reports help convince investors to take a risk on your growing business.
- Okay, Jim, let's imagine that we want to buy this building and convert it into a large ice cream production facility. How much do you think it would cost to get our ice cream business up and running? - [Jim] Well, if we want to do it right, buying the land, building and equipment and initial stock of raw materials, that's going to cost us a hundred million dollars. - See, I can see it in my mind's eye, the gleaming, stainless steel mixing vats. The happy employees wearing white clothes, white shoes, white caps to emphasize the cleanliness of our facility. The huge freezer storage room stacked with delicious ice cream-- - Yeah, that's a great vision, But back to reality.
Where would we get the hundred million dollars in financing to make this happen? If we want to buy a hundred million dollars in ice cream production assets, then we're going to need a hundred million dollars in money from somewhere to buy them. - That's why I included you as one of the partners. Surely, you've got a hundred million dollars tucked away somewhere. - Uh, not quite. And I don't think we can expect our friends and family to collectively come up with a hundred million dollars to invest in our business. - Well, couldn't we go door-to-door in your fancy neighborhood and ask your neighbors to invest in the extra money we need? - Yeah, we could do that, but the reality is, if we want to go from small-size business people to medium-size business people with assets of a hundred million dollars, we're almost certainly going to have to raise a lot of financing from strangers.
- From strangers? - [Jim] Yeah, strangers. A bank or a group of banks. Venture capitalists who are freelance investors willing to take a risk on a growing business in exchange for part ownership. - You know, we might even consider going public. To go public in the United States, you must file a business plan called a prospectus with the Securities and Exchange Commission, the SEC. - Correct, and once approved by the SEC, you can issue ownership shares to anyone in the world. In essence, anyone in the world can now become your business partner by buying shares in your corporation.
- Now remember, corporation is merely a collection of hundreds, or thousands, or millions of individuals who each own a portion of the company. - Now the key thing is that the vast majority of the shareholders are strangers to each other and are strangers to the people who are running the company on a day-to-day basis. - So how could we convince strangers, either banks or shareholders, to give us 100 million dollars for our ice cream business? - And this brings us back to financial records. We must provide potential investors most of them complete strangers to us, with summary financial statements to give them a concrete idea of what they would be investing in if they invested in our ice cream company.
- A key point here is that new businesses cannot get financing in a reasonable way without financial statements. In short, financial statements are essential to the modern functioning of our economy when we don't raise capital from friends and family, but instead we are typically raising capital from strangers. - Reliable financial reports are what make it possible to turn the dreams of entrepreneurs into the reality of actual businesses. - I like that. Financial reports turn dreams into reality. - Now the word reliable is important here.
Do we have an incentive to make our financial statements look a little better than reality? Of course we do. And strangers don't know whether they can trust our character or not. - This is where external auditing comes in. And to my knowledge, in every country in the world that allows companies to issue ownership shares to the public, the government regulators also require the company financial reports be audited by an independent, outside, third-party auditor. - Now these external auditors review the financial reports and the underlying recordkeeping system and aggressively question the assumptions and estimates made in preparing the financial reports.
- Correct. Now we're going to talk more about auditors in detail later. - Now reliable financial reports make it possible for entrepreneurs to convince complete strangers to provide the financing to turn their entrepreneurial dreams into reality.
- Creating a qualitative business plan
- Forecasting sales and expenses
- Capturing basic business data
- Understanding income taxes
- Preparing financial reports for auditors, investors, and other outside parties