How Raising Capital Impacts Your Financial Statements

Businesses need money to operate and unless your business has retained some earnings to draw from, you might need to go out and raise capital. Although there are complexities that blur the lines, you can broadly think of all capital as falling into two categories:

• Loan-based funding
• Ownership-based funding

Loan-based funding includes borrowing money from the bank or offering a bond or promissory note to private lenders. Ownership-based funding is essentially where you sell a piece of the ownership in the company as a share or stock. You’re probably already familiar with these concepts. But what I want to talk about in this blog post is how each type of funding impacts your financial statements. Knowing this will help inform you about the best choice for your situation when it comes time to raise some capital.

The balance sheet is split in two and is made up of assets on the one side and liabilities and owner’s equity on the other. Generating $1000 cash from selling shares will add $1000 to the assets side of your balance sheet and $1000 to the owner’s equity on the other side. Generating $1000 cash from borrowing that money will add $1000 assets to the one side and $1000 loan to the liability side.

The income statement also sees these types of funding appear on it. The interest you pay on loans and bonds appears in a “creditor’s section” (after you’ve figured out your operating expenses and net profit). And any earnings due to the shareholders are handled just below that in an “owner’s section”.

Lastly, the cash flow statement also sees the impact of these financing vehicles. If you think of the cash flow statement as being divided into “Operating activities”, “Financing activities”, and “Investing activities”, the loan-based financing and ownership-based financing appear in the “Financing activities” section. You’ll include proceeds from share issues, proceeds from debt, repayment of debt, and dividends paid out.

Don’t worry if this sounds confusing to you. Accountants deal with this kind of information every day. But it is important for you to think about when you go to get financing. For example:

• Loans often require regular monthly repayment, which will impact your financial statements regularly. Loan payments structured in different ways can impact your financial statements better in some months than in others. Some loans (like revolving loans) offer regular cash to your cash flow while other loans disappear once paid back.

• Shares offer an influx of cash, rarely require repayment (unless you’re buying them back from the owners) but it does mean that you’re giving up a portion of the company to someone else. Common shares (once sold) will impact your financial statements less than preferred shares, which often get dividend payouts on a regular basis.

Raising capital is important for businesses to maintain operations but raising the right capital is important. Understanding how that capital appears on your statements is one step toward figuring out which capital is right for you.