Author: Tanya Titman, Managing Director Date Posted: 18 December 2014
I recently introduced the concept of a Balance Sheet in my last blog. For many business owners, their Balance Sheet is part of the bundle of financial statements they receive from their accountant every year. Unfortunately it is often over looked or not referred to. The business owner's focus is on the Profit and Loss Statement and how much tax they need to pay. One of the most common questions I'm asked is "Why do I have to pay tax on my Profit when it's clearly NOT in my bank account?". Many business owners even doubt the figures are correct - as the profit showing in their Profit and Loss Statement does not come close to the cash position of the business. So, are the figures correct or is this just a revenue raising scheme devised by the ATO?
Well, I can confirm that your Profit (or Loss) as described in the Profit and Loss Statement is a correct measure of how your business has performed. There are a few factors that can influence 'how correct' the profit is but I will save that conversation for my next blog.
So, if the Profit is correct, then why is it not sitting in my bank account? The answer is in that ill-regarded financial report that you get from your accountant each year - the Balance Sheet. There is a direct link between your Profit and Loss Statement and your Balance Sheet. The Profit and Loss Statement shows how your business performed, the Balance Sheet shows where the profit went.
Don't just believe me - let's test it. Grab the last Annual Financial Statements prepared by your accountant. Your Balance Sheet usually shows you two periods - last year and this year. Calculate the movement in each line item in your Balance Sheet between these two periods.
For example, cash at bank this year was $35,000 and last year it was $20,000. So write down $15,000 next to this item. This indicates that $15,000 of your profit is in your bank account.
Accounts receivable (the money that your customers owe you) this year is $140,000 and last year it was $90,000. This indicates that $50,000 of your profit is currently 'funding' your customers (rather than sitting in your bank account). Continue through each item in your Balance Sheet and the sum of the increases and decreases in assets and liabilities should add up to your profit.
Your financial accounts should not be a mystery to you. Understanding the information in your Balance Sheet is essential for making good financial decisions. Imagine if you had this information at your fingertips every month rather than looking at it once a year. Would you have made different decisions in your business with up-to-date financial information?
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