Business owners have financial questions and the answers to these questions typically involve the ability to understand financial statements. This section of the learning library includes the answers to the following questions:
- Are you making money?
- Does your business have more than it owes?
- How much of the money in your bank account is yours?
- Is your cash flow positive?
- Who owes you money?
- Who do you owe money to?
Are you making any money?
The answer to this question is found on the income statement prepared for your business. The income statement shows you what you have billed to your clients and subtracts all of the expenses you have incurred, leaving you with the income you have earned. A positive number on the bottom of the income statement would indicate that you are making money, the higher that number is, the more money you are making. If that number is negative, then your expenses are more than your revenue. There are two overall strategies for fixing this – you either need to bill more to your customers, or you need to have fewer expenses. There are many tactics to achieve this goal.
In this example, the business has revenue of $55,000 which is the total of the bills sent to clients this year. These are the invoices sent, not the ones which have been paid. The business has expenses of $31,000 and the income is $24,000 being the difference between $55,000 and $31,000. The income tax is calculated and that leaves the business with a net income after tax on $20,000.
Click HERE to see the Sample Income Statement.
Does your business have more than it owes?
The balance sheet shows you the assets and the liabilities of your business. Assets are generally what you own and liabilities are what you owe. The balance sheet shows that comparison. Do you have more than you owe or owe more than you have.
This business has assets of $40,200 and liabilities of $29,200, the equity is the difference between assets and liabilities. When you see equity on a balance sheet it means that the business has more assets than liabilities, which we consider to be a good thing. When you see the word deficit or deficiency on a balance sheet it means the business owes more than it has.
Click HERE to see the Sample Balance Sheet.
How much of the money in your business bank account is yours to spend?
The balance sheet helps us with answering some questions like knowing how much money we have available to spend. This question is answered on the balance sheet because we can see how much money we have in the bank and also what we owe to others in this statement.
You might think that every dollar in your bank account is yours if you don’t have a running calculation of how much you owe for accounts payable and HST. Some of the money you collect from your clients is actually a sales tax that you have to send to the federal government.
An example, if you are collecting 15% HST then when you bill a customer $500 the invoice also includes $75 for the HST. When the customer pays you, the $575 you received went into your bank account, but you owe $75 to the government. Just looking at your bank account does not give you the breakdown of how much of the money in your bank account is actually HST collected from your clients. You need to look at the balance sheet which shows you the amount of HST owing, you then subtract that amount owing from your bank balance to figure out how much of the money in your bank account is yours.
In the sample balance sheet above the business has $3,000 in their bank account. You compare this number with their current liabilities. They have $10,000 in current liabilities. This business cannot pay all their current liabilities at one time. This is also somewhat surprising that the owe $6,000 in HST and they do not have $6,000 in the bank. They have used some of their HST money they collected from their customers to do things other than pay the HST to Canada Revenue Agency (CRA). This business would need to collect some receivables and sell some inventory to have enough money to pay all of their suppliers and also pay CRA.
Is your cash flow positive?
Being profitable is one thing, but if you haven’t collected the money from your customers yet, then you might not be able to pay your bills. Making money and having money can be two different things. You might be billing a customer today, which means you earn the money today, but the payment for that work might be months away. Some large organizations pay their suppliers in 90 days, if you are dealing with one of those customers then you will be waiting months for your money. You have income now but cash flow much later. Few people care how much money you’re making if you can’t pay them.
Click HERE to see the Cash Flow Statement.
Who owes you money?
When customers have been billed for work done by you, but they have not yet paid you, it is called an accounts receivable. Your accounting system should be able to generate a report of the people who owe you money and for how long they have owed you money. This is called a customer summary or accounts receivable trial balance. There are columns on this report. Each column shows you the age of your receivables. For example, the numbers that show up in the plus 91 day column of your Customer Aged Summary report are those clients who have owed you money for more than 90 days. The customers in the current column are those who have owed you money for less than 30 days.
Click HERE to see the Aged Accounts Receivable Summary.
Your accounts receivable will be security for your line of credit. When you have to wait for your customers to pay you, you may have to borrow money in order to pay your employees and your suppliers. When you do this sort of borrowing, the security is typically the list of accounts receivable.
A bank may not consider your accounts receivable which are over 90 days to be good assets. If that is their policy you will not be able to use any of the older than 90 day accounts receivable as security for your line of credit, which will mean that you will have a lower line of credit available to you.
Who do you owe money to?
When you have purchased products or services you have an expense. But like the accounts receivable discussed above you have the expense but you may not have spent the money as of yet. If you have yet to pay the supplier whose product or service, you purchased then you have an accounts payable. A list of the people to whom you owe money would look like this summary:
Click HERE to see the Aged Accounts Payable Summary.