Lesson B202.2 · Business Finance 202: Build a Business Worth Buying
Read your financial statements like a buyer
5-minute read · Figures checked October 2026
Photo: Lukas Blazek / Pexels, Pexels License
The short answer
Three statements tell a buyer or a banker how your business works. The profit and loss shows whether you made money over a period, the balance sheet shows what you own and owe on one day, and the cash flow statement shows where the cash came from and went. Read them every month, track a few ratios against your own past, and back every add-back with paper.
Three statements, one story
| Statement | What it answers | What a buyer looks for |
|---|---|---|
| Profit and loss | Did we make money this month or this year? | Steady revenue, steady gross margin, costs that make sense |
| Balance sheet | What do we own and owe today? | Cash, receivables that get collected, debt in line with net worth |
| Cash flow statement | Where did the cash come from and go? | Profit that turns into cash, not into old receivables |
They connect. The year's profit flows into owner's equity on the balance sheet. The cash flow statement starts with that profit and explains why the bank balance moved: customers paid or didn't, equipment was bought, loans were paid, the owner took draws. That's how a profitable October can still end with less cash than September.
Cash-basis books record income when the money arrives. Accrual books record it when you earn it and send the invoice, and record costs when you owe them, so each job's income sits next to its costs. Ask your CPA which basis your books and tax return use. A buyer will ask too.
Five ratios worth knowing
Example (made-up numbers, not a benchmark or a target). Lena (example) runs the office at a six-person sealcoating company. Here are last year's numbers and ratios.
| Ratio | Formula | Lena's company | What it tells you |
|---|---|---|---|
| Gross margin | Gross profit ÷ revenue | $288,000 ÷ $800,000 = 36% | What each sales dollar leaves after job costs |
| Net margin | Pre-tax profit ÷ revenue | $48,000 ÷ $800,000 = 6% | What's left after overhead too |
| Current ratio | Current assets ÷ current liabilities | $150,000 ÷ $120,000 = 1.25 | Whether bills due within a year are covered |
| Debt to net worth | Total liabilities ÷ net worth | $300,000 ÷ $150,000 = 2.0 | How hard the business leans on borrowed money |
| DSCR | Cash available for debt payments ÷ debt payments | $90,000 ÷ $60,000 = 1.5 | Whether the business can carry its loans |
Swipe the table sideways to see every column.
Lenders set their own limits. One bank's published guide looks for total liabilities at or below 4 times net worth, and banks often prefer a DSCR of 1.25 or higher. Margins have no right answer for every business. Compare yours with your own past years and your own goals.
Add-backs need paper
An add-back is a cost you ask a buyer to ignore because a new owner won't have it: your own salary, a one-time repair, a lawsuit that's settled. Buyers and their accountants test add-backs line by line. The ones without paper come out, and each dollar that comes out lowers the price by that dollar times the multiple.
For each add-back, keep the invoice or payroll record, a one-line reason, and proof it won't repeat. Personal costs don't belong in the business books at all. If some slipped in, list them, prove them, and stop the practice now. Buyers trust books more when they see clean years, not explanations.
You choose how much outside checking your statements get. A CPA can compile them (standard form, no assurance), review them (questions and analysis, limited assurance) or audit them (testing the records, high assurance). Each step costs more. Lenders ask for more assurance as loans get bigger: Ameris, an equipment lender, asks for reviewed or audited statements on loans over $250,000. Buyers often pay for their own deeper check, a quality of earnings report (B202.9).
Your Move
Do this week
- Close the books for the last three months: reconcile every bank, card and loan account.
- Print the profit and loss for each month and the balance sheet at each month-end.
- Figure the five ratios for the latest month and for the same month last year.
- Circle one number that surprised you and write down why it moved.
- List each add-back you'd claim and the proof you have for it.
Log it: Three months of statements read.
Common questions
What's the difference between a profit and loss and a balance sheet?
The profit and loss covers a period, like a month or a year, and ends in profit or loss. The balance sheet is a snapshot of one day: what the business owns, what it owes, and the difference, which is net worth.
Do I need audited financial statements?
Most small businesses don't. Lenders and bonding companies ask for more assurance as the amounts get bigger, so ask what your lender or buyer needs before you pay for a review or an audit.
Why did my profit go up while my cash went down?
Profit counts work you've billed; cash counts money that arrived. Unpaid invoices, equipment purchases, loan principal and owner draws all use cash without showing up as costs on the profit and loss.
Watch out for
- Statements that don't match your tax returns. Buyers and lenders compare them line by line.
- Owner draws booked as expenses, or expenses booked as draws. Both bend the profit number.
- Old receivables carried at full value. A buyer will discount invoices that haven't been paid in months.
- Books brought up to date once a year. A year of catch-up entries is hard for a buyer to trust.
The National Pavement Maintenance Contractors Association (NPMCA) publishes this lesson. NPMCA's data affiliate may earn fees from private-equity introductions. The lesson above is the same either way.
Free help
- America's SBDC: free one-on-one business consulting. Find your SBDC
- SCORE: free mentoring from experienced business owners. score.org
Free practice
Lesson check
5 questions on this lesson, one at a time, with the answer and the reason after each. Pass with 4 right, including every must-know question.
This is general education, not tax, legal, investment or insurance advice. Rules change and every situation is different. Check the sources below, and talk to a qualified professional before you act on it.
Sources
- AICPA & CIMA: What is the difference among a compilation, review and audit?
- PNC (one bank's guide): Business lending guide
- Chase: What is the debt service coverage ratio?
- Ameris Equipment Finance: Small business loans FAQ
- BizBuySell: Seller's discretionary earnings and add-backs
- NASBP: Surety prequalification goes beyond the three Cs
- America's SBDC: Find your SBDC; SCORE: score.org
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