Q: I purchased an accounting software program to handle
my finances. But when I run the reports, I'm more confused than
ever. My income statement says I made a profit of $40,000, but my
checking account is empty. Help!
A: Darn it! It's always disappointing when your
profit doesn't necessarily mean more cash in the
bank-especially when you realize you have to pay taxes on that
profit! Go ahead. Cry a little. Now, I'll help you understand
how this can happen.
Your income statement (aka profit and loss statement, or
P&L) is a handy financial report. It shows money in (income,
revenues, sales) and money out (expenses, costs.) More money in
than money out creates a profit. More money out than money in
creates a loss. Profit is better than loss. So far, this is pretty
clear-cut, right?
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Now, profit is also reflected in another financial report: the
balance sheet. Think of the balance sheet as the ultimate
scorecard for your business. The balance sheet is based on this
equation: Assets = Liabilities + Equity. Here are the simplified
definitions of these accounting terms:
- Assets: The stuff. The goods. What you have.
Assets include cash, accounts receivable, inventory, tools,
vehicles, buildings, real estate and so on.
- Liability and equity: Who has dibs on the stuff. A
liability is what you owe. Equity is what you
own.
What you own is recorded in the equity accounts. Claims on the
assets by someone other than you are recorded in liability
accounts.
The income statement is a report that shows changes in the
equity section of the balance sheet as a result of business
operations. (Hang with me--I know this gets a bit confusing.) Think
of your income statement as a magnifying glass on the equity
section of the balance sheet. It shows you the details--money in,
money out and what's left over. What's left over is profit,
and the profit is reflected in the equity section of the balance
sheet. Pull out your own financial reports. Notice that the current
earnings line of the equity section matches the profit line on the
income statement.
A profit increases the equity in your company. Cool! Because
there will be an equal increase on the asset side of the balance
sheet. Very cool! Remember, the balance sheet has to balance. So
profit creates an increase in equity and assets. That's the fun
part.
Now, remember there are different kinds of assets: cash,
accounts receivable, inventory, tools, vehicles, buildings and real
estate. You have $40,000 in profit. Great! Your balance sheet will
show an increase in your equity of $40,000. (Check the current
earnings account.) The total increase on the asset side of the
balance sheet will be $40,000. But that $40,000 can be in cash,
accounts receivable, inventory, tools, vehicles, buildings or real
estate. Where it falls depends on if you collected on the sales in
the first place (accounts receivable), or maybe you spent the cash
on more inventory, tools or a new truck.
And that's why the profit amount isn't the amount
in your checking account.
Promise me you'll run a balance sheet, income statement and
cash flow report every week. No more surprises. Have your
accountant check your accounting work until you're certain the
reports are accurate. Keep your chin up. You're getting smarter
by the minute!
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More | |
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| Use the
income statement to measure business revenues vs. expenses. Check
out
"Income Statement." |
Author Ellen Rohr nearly starved in her family's small
contracting business-until she learned how to manage money.
"Do what you love, certainly," she says, "but the
money won't just take care of itself." Ellen's pricey
college education didn't prepare her for real-world business.
"Financial business basics aren't that difficult…but
where do you learn them? Unfortunately, business literacy isn't
taught in school. I teach the basics and take the mystery out of
making money." Ellen's mission as an author, columnist and
seminar leader is to help people make a living doing what they
love.
The opinions expressed in this column are those
of the author, not of Entrepreneur.com. All answers are intended to
be general in nature, without regard to specific geographical areas
or circumstances, and should only be relied upon after consulting
an appropriate expert, such as an attorney or
accountant.