As a business owner, you need to refer to and rely on your business financial statements to make decisions and assess how your business is progressing overall. This is where the Financial Statements come in.
We will take an in-depth look at two of the most commonly used reports. We will start with the Balance Sheet. We find that oftentimes business owners underestimate the importance of this statement and the information that can be drawn from it.
THE BALANCE SHEET
This statement reports the business assets, liabilities, and shareholder equity as of a specific date. Tip 💡Think of this statement as a photograph of the financial situation of your business on a specific date - typically the last day of the fiscal year.
Some highlights about the B/S statement:
The Balance Sheet is broken into 3 major sections. Assets, Liabilities, and Shareholder’s Equity.
The balance sheet must balance. This is to say that total assets must equal or "balance" to the sum of total liabilities plus shareholder’s equity.
Assets can be very liquid or current - for example, the balance in the business chequing account.
Assets can also be long-term or non-current like Investments, Equipment, Furniture, and Inventory.
Liabilities represent the debt that your business carries.
Liabilities are also broken down into current and long-term or non-current liabilities.
Examples of current liabilities are credit card balances and CRA balances due that are due to be paid in less than twelve months.
Non-current or long-term liabilities are loans that are expected to be paid past the twelve-month mark.
Shareholder’s Equity represents the investment of the owner in a business -either by income generated in previous fiscal or calendar years or by investing money in common or preferred shares.
Note that the Balance Sheet gives you an overview of the health of your business as it accumulated over the periods. An incorrect bookkeeping process two years ago will still impact today's balance sheet statement. For instance, if your bank account has transactions in cleared status after the books have been reconciled. This means that the bank account will display a distorted balance since it is accounting for cleared and reconciled transactions. Another source of error could be not keeping accurate track of CRA dues paid. If interest accrued and paid are recorded against the liability account the books will be out of balance.
Tip 💡 Proper bookkeeping is key if you want to rely on financial statements to make sound business decisions. If you have noticed "wonky" balances (ie. negative balances in your liability accounts, banks accounts that do not match bank statements) reach us. We'll be happy to assess your books and suggest an action plan that suits your business needs and budget.
THE PROFIT AND LOSS STATEMENT
Most business owners are very familiar with this statement, this is the little darling of all statements. It is also known as the Income Statement or Operating Statement. Tip 💡 Think of this statement as a movie about your business activities. Did the movie have a happy ending resulting in Net Profit or did it have an unfortunate turn of events that resulted in a Net Loss?
Some highlights about the P&L statement:
It provides an overview of how much revenue or income the business brought in.
The revenue or income can be grouped based on different revenue streams such as Design Fees, Sales of Goods Income, Commission Fees, and Other Income not related to business activities such as Interest Income
The revenue or income is subtracted by all the expenses incurred during a specific period.
The expenses can be directly related to the revenue or income earned, such as the cost of goods or services sold and there are also overhead expenses or expenses incurred when running a business such as insurance, rent, and bookkeeping
The difference between these two major categories (Revenue/ Income and Cost of Goods or Services Sold/ Expenses) results in Net Profit or a Net Loss
Net Profit is also known as Net Income, Net Earnings.
Note that the Profit and Loss Statement is typically calculated on an accrual basis. The accrual basis means that the revenue or income is reported based on the date your business issues an invoice. The date of when your business receives payment from its clients does not trigger revenue recognition - unless your business reported income on a cash basis (which by law very few types of businesses are allowed to do so). Similarly, expenses are reported based on the date of your vendor’s bill. Again, the date that your business settles payment with this vendor does not play a role in expense recognition.
For Corporations, corporate taxes are calculated on the Earnings before interest, taxes, and depreciation.
Tip 💡Interest and taxes refer specifically to interest and penalties paid to CRA for late filing, late installment payments, and interest incurred. Taxes are defined, in this instance, as the corporate taxes payable or paid for the fiscal year being. And depreciation refers to is the loss of assets' value - this is a fictitious or assumed loss in value based on a CRA prescribed rate.
Curious to learn more about your Financial Statements and how to read them and draw more conclusions? You should read our blog about Business Margins and Ratios. Click here.
If you have more questions on how to improve your bookkeeping to help you improve your business decision making then contact us using our Contact Us Form.