It isn't my intention to make accountants out of our LegalBees. That isn't your job, and it is true that it is best left to the professionals. However a successful business is a team effort. As the Business leader you will need to have some knowledge of accounting to be an effective decision maker. My job is to teach you the wee bit that you must know to set a course and keep to it so that you can actually arrive at the destination you choose.
You probably figure that the income statement shows how much money the company took in over the period, what it spent and what is left over is the profit, correct? Actually no. that would be the case if the company was using a cash method. Cash method might be okay for a brand new operation where the transactions are simple and the owner can keep track of everything in her head. The problem with such operations is that no one else will understand what is going on. There is no accurate picture of the business at any point of time. That is why most companies use what is called accrual accounting.
In accural accounting sales (Revenue) is matched to Outgoing monies. For example say you purchase a vehicle to use for the business. Instead of declaring the whole cost in the month that it is purchased you might use straight line depreciation. In this case if the loan is for three years you would earmark the cost as 1/36 of the actual cost, so that the operation shows a more representative picture of what the vehicle is costing each month as it is used to get you from one appointment to the next.
Likewise if you make a contract to help a social services agency with child custody cases and the deal involves a hundred thousand dollar annual fee, you wouldn't show that whole hundred grand as revenue in the same month that you deposited the check. You have to have a way to recognize income that is representative of the work actually performed over time. As part of that contract you will be working for the agency over the coming year, so you might set it up to recognize $8,333.33 each month (times 12 equals 100K) In this way you are able to better match your revenue with expenses incurred while delivering the service that you provide. This includes payroll, office supplies, overhead, advertising, telephone, interest and principle payments on loans and taxes.
The two examples above is what an accountant does, that is apply what is called the matching principle. As the Queen Bee of your hive your job is to ensure that there is sufficient revenue each month to meet all of your outgoing expenditures while retaining a bit so that there is a reserve for things like expansion, bonuses to reward yourself and your team and replacement of equipment. If there is sufficient revenue but no profit you will find yourself in a pickle when you need to replace your laser printer, or when the transmission on that car needs fixing a few weeks after the service warranty expires.
It is also possible to spend too much or to have too little sales so that you actually lose money, a loss on the income statement is a bad situation. A loss that the company cannot turn around is the worst scenario. No company can sustain losses indefinitely. It is best to work on your financial controls right from the beginning and plan carefully to make your company as profitable as it possibly can be.
This means set realistic sales goals then exceed your own expectations! Watch those expenses and communicate with your accountant before making large purchases. Always do a risk/reward analysis for every financial decision. Sometimes the best investment is to take the dollar that you have and fold it over and put it back into your own pocket.
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