Banks / lenders will require three years of past financial statements at a minimum. The reason is to see if your business could have serviced the loan over the last three years. If it passes this test, then your business should be able to service the loan for the next three years.
Thus, they use your past business performance to determine what your future performance should be.
To spread your financial, most lenders will do the following for each past period that your business provided financial statements:
- Take your net income (that is your net profits after all operating costs, taxes and interest payments).
- Add back any non-cash accounting items like depreciation (deprecation is not an ongoing cash expenses but an accounting anomaly to reduce taxable income for tax reporting purposes only).
- Add back any one-time charges or expenses – expenses that are not expected to reoccur in the future.
- Then subtract out the interest charges for the proposed loan – only the interest portion at this stage as interest payments are considered regular business expenses.
This results in the true net positive (hopefully positive) cash flow of the business – cash flow that will be used to pay the principal portion of the business loan.