So how do we interpret the reports we suggested last time? The easiest way to understand reports is to understand the different components that make them up. Let’s start with the
profit and loss report:Revenue
If you run a service-based business, you provide services to clients and the income that is generated is revenue. If you’re a product-based business such as a wholesaler or retailer, then the income you generate from the products you sell are classified as revenue.
Some other examples include: interest received, insurance proceeds, traineeship or apprenticeship employment incentives.
At no stage do any items that appear in the profit and loss include GST. All items are GST exclusive, as GST is not your money; it belongs to the tax office. You are simply the collector of that money.
So to further define, what is NOT revenue? Some monies that are received are not classified as revenue and as such would appear on the balance sheet instead. This could be an injection of funds by yourself (capital introduced) or your bank (in the form of a bank loan).
Expenses relate to items that you have purchased or services received that relate to the running of your business and the generation of the revenue.
Obviously they need to relate to the operation of your business and be utilised for your business. Legitimate expenses vary from industry to industry. For example, an accountant would not be able to claim a lawnmower as an expense because that would obviously be a personal expense unrelated to their business.
However, a garden maintenance man would have every reason to claim a lawnmower as an expense (whether this was fully expensed or actually depreciated as an asset would depend on their tax situation).
The key is that expenses claimed must be related to your business.
Some monies that come out of your bank account do not appear on the profit and loss statement at all. Examples of these include drawings to you, loan repayments, credit card payments, purchases of assets over a certain value, car payments, payment of tax, super and so on.
The treatment of these expenses in your books are dependent on certain tax dealings and thus can differ between businesses. If you wish to know more about your individual situation, ask your tax accountant about how it should be treated in your books.
So why, apart from the above, could you be making a profit but not have any money in your bank account? The other factor relates to accrual versus cash accounting, which means that you invoice someone and the revenue from that sale will show on your profit and loss but your customer has not paid yet.
The other side of the equation relates to invoices from suppliers. If you enter those into your accounting system and they have not been paid yet, they will appear as expenses on your profit and loss report but you have yet to pay for it. If, on the other hand, you only enter items (both sales and expenses) in your accounting system AFTER they have been paid then this factor does not apply. However, this method will not generally give you the complete picture of where your business is at.
And what if you have a loss? This basically means that your expenses (spending) are greater than the revenue you have earned. Scary I know, particularly if you haven’t looked at it before. You may have had an inkling that you were making a loss and been burying your head in the sand about the whole thing.
Once you’ve decided to acknowledge the losses, the first thing to do is check unusual item lines in your profit and loss. Perhaps you bought several computers worth $5000 and they have been mistakenly classified as an expense on your profit and loss report rather than classified as an asset in the balance sheet. You can also ask your accountant or bookkeeper to run a practised eye over your line items.
What if you’ve corrected mistakes in your line items and are still making a loss? Don’t worry, it’s not the end of the world. At least you know what’s going on, so you can take immediate action to avert financial ruin. Of course, it’s not a desirable place to be, but you can always get yourself out of losses.
It’s important to have a look at how losses are being funded. If your expenditure is greater than your revenue, these expenses are being funded by creditors, loans, personal cash injections or credit cards. I have seen more than one business fail when trying to sustain losses. It’s a situation that requires immediate action.
So what do you do? Talk to a professional – your bookkeeper, accountant or tax accountant – preferably someone who understands your business and what you are trying to achieve. The sooner you can take action, the sooner it can be rectified.
Remember that business is about making money, not losing it!