Tony Bender

Now we are moving on to the Income Statement.  While the Balance Sheet is a snapshot of what is owned and owed, the Income Statement is a summary of amounts earned (income) and expenses during a period.

Another difference is that the Balance Sheet is taken as a snapshot in time…it is “as of [Insert Date]“.  The Income Statement is for a range of time like January 1, 2011 to December 31, 2011.

There can be a lot of confusion around income.  So, it I thought I might start with an overview before tackling some of the more detailed concepts.

Words like revenue, earnings, income, and profit are often used interchangeably when, in fact, they are not.  It is further complicated by uses of terms gross, net and margin, and the inconsistency in the reporting of those numbers.

Gross revenue typically refers to just the revenue from sales.  Gross margin (or sometimes “income”) can actually refer to the net of the sales revenue and the Cost of Sales.

For instance, if you sell a widget for $100 and it costs $30 to make the widget, your gross margin might be $70.  Note that the Cost of Sales (sometimes called Cost Of Goods Sold or COGS) is still an expense.  It is not uncommon, though, to net it with sales since the cost is directly incurred along with sale.  In fact, these are often referred to as Direct Costs.

The other expenses of the business are usually called Indirect Costs.  These costs are incurred whether or not sales are made.  Interest expense, insurance, and supplies expense, are all examples of expenses.

When all revenue are netted against all costs (expenses), the result is net income (or profit).  When you divide the profit by the revenue, you get the profit margin.  It is important that you focus on margin instead of dollars because dollars can be easily distorted.

For instance, if a company has profits of $200,000 in a year, that might sound good and, indeed, it might be.  However, if that was on sales of $10 million, it would provide an entirely different picture.  That is only a 2% profit margin.

Even in industries with lower margins, that would be fairly low.  The only challenge with using margins is that you need to consider the industry since each has its own standard margin.  Five percent might be acceptable in one and entirely unacceptable in another.

As you can see, the concept of income is not always straightforward.  It is important to not only look at your income, but to monitor your margins to determine if you are getting the most out of your resources.

In my previous post, I mentioned the Income Statement and Balance Sheet.  Today, I thought it might be a good idea to expand on the Balance Sheet.

As stated previously, the Balance Sheet is a summary of things you OWN and amounts you OWE.  The things you own are called Assets while the amounts you owe are recorded as Liabilities.  There is another group on the balance sheet called Equity.  This third group is sort of optional as it only applies if there is a need/desire to record the equity one or more people have in the company.

Some of the more common assets include:

• Cash
• Inventory
• Accounts Receivable
• Property
• Supplies

Liabilities, on the other hand, are amounts owed.  This would include any debts in the name of the business, typically loans and/or accounts payable.  When you buy something today that you will pay for later, that would be considered accounts payable.

Also, if you are prepaid for services, those would also be considered liabilities until services are rendered.  For instance, if a roofing company is paid $2000 before starting to work on a roof, the $2000 would be classified as a liability until the work is performed.  It might be easier to grasp the concept if you think about it like this:  If the work is never performed, the $2000 would have to be returned.  It actually hasn’t been earned yet.

The third classification on the balance sheet is equity.  This is intended to represent the owner(s) equity in the company.  For large corporations, this represents a substantial part of their capital.

For a sole proprietor, this is usually ignored.  However, I recommend maintaining it because it can help you determine if the company is standing on its own or being propped up by your personal investment.  One simple way to help manage this is to open separate bank accounts for the business and avoid mixing your business and personal accounts.  If you want to use personal money for the business, make a deposit into the business account and record it so that it the business will show it as an increase in the owner’s equity.

As always, feel free to send me a message with any questions you might have.

This is the first article in a series about accounting.  As such, I think it makes sense to start at the top.  Keep in mind that this is written for non-accountants, so it does not dive in to the more complex topics.

Accounting is just what the name implies.  It is the process of taking into account all activity of the business.  Somewhat shockingly, it actually uses something called “accounts” to do this.

Accounts are classified into several types.  At the highest level they are split by which accounting report they show up on…Income Statement or Balance Sheet.

The Income Statement, also referred to as Profit and Loss (or P&L), is what most people think of in any business setting.  It is a summary of income, or money brought in, and expenses, or money paid out.  You could have multiple income accounts if, for instance, you want to split income from a variety of sources.  Expense accounts would be things like insurance expense or supplies expense.

The Balance Sheet is a summary of things you OWN and amount you OWE.  This is shown in the form of assets and liabilities.  An asset (something you own) could be cash, supplies, inventory, accounts receivable, property, etc.  Liabilities (amounts you owe) are generally debts like loans or invoices not yet paid (accounts payable).

Many small businesses operate on a cash-basis.  This concept will be covered in a later blog, but it effectively reduces the amount of entries you might see on the Balance Sheet and, therefore, its value.

For some very small businesses operating on a cash basis, the Income Statement is more or less a reflection of the bank statement.  If you buy things that are consumed or sold quickly (no inventory), and you have no debt, the accounting effectively boils down to money in and money out.

Ultimately, isn’t that what it is all about.