Wednesday, December 18th, 2024
You’re a home based business making money as a freelancer, an affiliate marketer or a professional such as a contractor. Perhaps you’ve got a corporate business downtown. You may be wanting to learn the true worth of a business, so it’s important to understand what financial statements are.
While all these terms and numbers may initially be confusing to you at a glance, the information you need should be available to you, and be easy to understand.
The definition of a financial statement or financial report, is the record of any business’ financial flows and levels.
Two Types Of Accounting Methods – Cash Or Accrual
When first starting a business, you need to determine the method you are going to use for accounting and paying taxes.
The choices your have are the cash method or the accrual method.
1.) – Cash Method
If you are looking for simplicity, the cash method is probably your best accounting choice.
Generally, income and deductions can be claimed when the payment is actually received or made.
For example, you open a small business and order business cards and stationary. You received the products and paid the invoice on September 17th, 2021.
Under the cash method, you can deduct the cost of these expenses on your 2021 tax return.
Keep in mind there are some types of businesses, who are restricted from using the cash method.
2.) – Accrual Method
The Accrual Method of accounting can be a bit more complex. Using this method, the focus is on the date the expense was incurred, and not when the invoice was paid.
Although this may seem like a minor difference, it can play havoc with your books once tax time arrives.
Using our previous example. Say you order business cards and stationary on December 17th, 2020.
You receive the product on December 27th, 2020, but you don’t pay the invoice until January 20th, 2021.
Under the Accrual method, you may be wondering when you can claim the expense. What it depends on, is when the “economic” performance occurred.
The definition of economic performance, is the date when the goods or services were provided to you.
In the example, “economic performance” occurred once the business cards were delivered with the invoice, on December 27th, 2020.
Thus, you would be able to deduct the expense in the 2020 tax year, although the invoice was paid in 2021.
Choosing Cash Or Accrual
The cash method is a lot easier of the two accounting methods. To determine the best method for you and your business, is up to you. Talk with a Tax Expert.
Know The Four Financial Statements
1. Balance Sheet: A balance sheet describes a company’s assets and liabilities.
2. Income Statement: An income statement describes a company’s income and expenses.
3. Statement of Cash Flow: A cash flow statement describes how a company’s operating, investment, and financing activities have affected their cash position.
4. Statement of Retained Earnings: Describes changes to shareholders equity (for example a payment of dividend).
At times these statements can be complex, as an extensive set of “Notes” to the Financial Statements and management discussion and analysis, are usually included.
These notes will typically describe each item on the Balance Sheet and Income statement in further detail.
In most cases, the notes are much longer than the financial statement they are elucidating.
This occurs if a company has extraordinary items affecting its balance sheet, or the shareholders equity position.
It will usually include an “Other Comprehensive Income Statement,” which describes the adjustments to be made.
Examples of Other Comprehensive Income, includes revaluation of corporate assets away from their stated cost, as well as accruals for liabilities.
What Is An Income Statement
An income statement, otherwise known as a profit and loss statement, is a summary of a company’s profit or loss during any one given period of time.
This period of time could be a month, three months, or one year.
The income statement records all revenues for a business during this given period, as well as the operating expenses for the business.
It is extremely important to format an income statement, so it is appropriate to the business being conducted.
Income statements, along with balance sheets, are the most basic elements required by potential lenders, such as banks, investors, and vendors.
They will for instance, use the financial reporting contained therein to determine credit limits.
Statement Of Changes In Financial Position
A statement of changes in financial position, is also referred to as the Cash Flow Statement.
What it does is reports the amount of cash coming in (cash receipts), and the amount of cash going out (cash payments or disbursements), during a specified period.
Business activities can result in either a net cash inflow (receipts greater than payments), or a net cash outflow (payments greater than receipts), during a period.
The cash flow statement shows the net increase or decrease in cash during the period, and the cash balance at the end of the period.
What it explains are the causes for the changes in the cash balance. The cash flow statement covers a span of time.
What Is A Balance Sheet
A balance sheet, in formal bookkeeping and accounting, is a statement of the book value of a business, organization or a person at a particular date.
This record is often at the end of its “fiscal year.”
It’s distinct from an income statement, also known as a profit and loss account (P&L), which records revenue and expenses over a specified period of time.
Definition Of An Asset
An asset is any item of economic value that’s owned by an individual or a corporation, especially if it can be converted into cash, and thus has monetary value.
Examples are cash, securities, accounts receivable, inventory, office equipment, real estate, a car, and other property used in the business.
On a balance sheet, assets are equal to the sum of liabilities, common stock, preferred stock, and retained earnings.
From an accounting perspective, assets are divided into the following categories:
• Current assets (cash and other liquid items)
• Long-term assets (real estate, plant, equipment)
• Prepaid and deferred assets (expenditures for future costs such as insurance, rent, interest), and
• Intangible assets (trademarks, patents, copyrights, goodwill)
What Are Liabilities
The definition of a liability, is it’s a current obligation of the company, arising from past events.
The settlement of which is expected to result in an outflow of cash from the company resources, embodying economic benefits.
What Is Owner’s Equity
Owners equity is defined as total assets minus total liabilities, of an individual or a company.
For a company, it’s also known as net worth or shareholders’ equity, or net assets.