DEMYSTIFYING FINANCIAL STATEMENTS
Every year – scratch that, sometimes every month – I print out (aka PDF) these fancy reports from QBO and send them out to our money management clients. I ask them to review and let me know if they see anything wonky or if they have any questions or concerns. I guarantee you this is what happens on the other end of that email:
In 8+ years and 50+ clients, I can count on one hand, the responses I’ve received.
Nope. All I get is crickets. No response means everything looks good right? I’m guessing, wrong.
So, let’s demystify these stupid reports, so next time I (or your accountant) sends you these things, you’ll actually know what you’re looking at – and why!
This will be the first in a series of articles; we’ll start by going through all the “reports” that you might get, and in upcoming articles, we’ll dive into each report to REALLY see WTF they’re talking about.
So – Big Picture: What are these reports being sent to you!?!
First off, “financial statements” are first and foremost, an accountant’s way of showing the full money picture of your business. No ONE report shows the whole picture, and while one report looks good, the another might tell a completely different story.
Your financials are basically that – a “story” of how your business is doing. Unfortunately, only a select few have been taught the language that the story is written in. Talk about the epitome of patriarchal superiority complex. But I’m here to break down that language barrier and become your Duolingo for financials ;)!
ACCRUAL VS. CASH
The overarching basis that you need to know about how your financials are created, is that they are ACCRUAL based, not CASH based. [And WTF does “accrual” mean, Tanya!?!]
Well let’s use an example…
I don’t know if you’re like me, but I pay for EVERYTHING on my credit card. On our personal side of things, I have a WestJet Mastercard, and my MO in life is to NOT pay for flights (or at least, not much).
So when I get groceries, I put it on my credit card, and ~30 days later I pay my credit card bill (and rack up those WestJet dollars!!). If I buy these groceries in January, I technically won’t pay for them until February, when I pay my credit card statement. With me so far?
Alright, then, in the “accrual” accounting world, those groceries would be a JANURAY expense; in the “cash” world, they are a February expense (cause that’s when I actually paid cash for them). When you look at your bank account in January, though, you’ll be like – whatever?! I’ve got $300 more than my expenses say I should!? And then you’ll proceed to call all this money management shit bullshit and vow never to pay attention to accounting quacks again. Ok maybe not that extreme, but something along those lines.
If we lived in a world without credit cards, loans, lines of credit or payment terms, then this wouldn’t be so difficult. The reality is, though, that with these (very useful!) tools, we can delay payments on many expenses, for the cost of a few interest $$’s.
Bottom line – accrual accounting means that we track sales when you issue an invoice, and expenses when you make the purchase, or in the case of assets, when you sell/use something. It has nothing to do with when money actually enters or leaves your bank account.
INCOME STATEMENT
Sometimes called a Profit/Loss Statement, this one shows your revenue or sales and your expenses. Now I know your probably thinking – “well what’s so “incomplete” about that?! What else is there? Sales and Expenses kind of covers it right?!” Well no, not really. Remember that whole accrual rant above?
Your Income statement will show you what sales you made in a particular month/year, not necessarily when you got PAID for those sales. If you’re a retail business, then no problem – you collect payment at the same time the purchase is made; easy peasy. If you send out invoices and rely on your customers paying you themselves, then chances are you’re dealing with a time delay between sending an invoice and getting paid. Your Income Statement only cares what date is on that invoice, not what date you were paid.
Same deal on the expenses side. If you order something from a supplier and they send you and invoice that isn’t due till next month (i.e. NET30), your income statement only cares about the date on that bill. It too, cares less about when you actually pay it… or how you pay it… or if you pay it!! ;P
Bottom Line - Sales MINUS Expenses = Profit (or Loss). Generally speaking, this Profit/Loss is what you pay taxes on. It is NOT reflective of what is in your bank account. This is the most confusing thing about income statements/financials – your profit/loss is just a “paper number”; it means something to accountants, investors, and CRA, but its meaningless when it comes to knowing what’s in your bank account, and what you can/can’t afford to do.
BALANCE SHEET
So how the hell do you know what’s in your bank account?! Well other than opening your online banking portal and looking (I’m a smart ass I know), you’ll also see your bank balance when you look at your Balance Sheet.
Your Balance Sheet, in a nutshell, shows you what you OWN and what you OWE. It shows your assets, liabilities, and equity.
Assets
Things that are of value to your business – the cash in your bank account, the money owed to you by customers or payment services (i.e. money that square still needs to transfer to you), inventory that you have/isn’t sold, and equipment, tools, furniture, etc that you own/use for your business.
Liabilities
Money that you OWE to others – i.e. credit card debt, loans or lines of credit, taxes owed to governments, etc. If you’re a corporation, you may also have “shareholder loans” – this is money that is essentially owed to you – but since “you” are a separate entity from the corporation, in this case you are one of those “others”. One thing to keep in mind…shareholder loans can go both ways. You might put money into the business to help with cashflow, you might need (or accidentally) buy something for the business on a personal credit card, or you might use some of your personal property for the business (think home office or vehicles). In either of these cases, the business now OWES you that money, and at some point, should pay you back.
On the other hand, who hasn’t accidentally bought groceries for yourself using the business card – they all look the same, right!?! Or you just transfer yourself money from the business account, instead of running payroll. Don’t stress about this – It’s very normal for our business and personal lives to blur, and that’s where the “shareholder loan” account comes into play. There’s accounting magic that deals with it all so don’t worry!
Equity
It is the bottom line of what’s left over. Let’s look at equity in terms of a home. You have a house; say you sell it for $500,000. This is your asset. On the other side, unless you have or are Daddy Warbucks, you have a mortgage (debt/liability). When you sell your house at 500K, and then pay off your mortgage – say its $300K – then you get $200K to either put into a new house, or go on some amaze-ball trips. That $200K is your equity.
On your balance sheet, this means, if you decided to close or sell your business, you’d take all your assets, sell them off and use that money to pay off all your debts. Whatever’s left – that’s what you get for 20 years of blood, sweat, and tears.
Bottom Line – Assets = Liabilities + Equity
Ok – those are the big ones. There’s more reports that you might see, but let’s start there and leave it at that. Did I make your ears bleed?! Remember this is just the high level stuff – I’ll get into more details and language training in the coming weeks.
But if all this has done is raise MORE questions, don’t sit there confused or wondering – drop me a message and ask away!!