Edmonton CPA | Why Entrepreneurs Need To Read Income Statements
Many business owners do not have previous business ownership experience says Edmonton CPA. And they need to learn their business finances as they are growing their business. And if they do not learn fast enough, they put their business in jeopardy.
This is why the failure rate for entrepreneurs in Canada is so high. 15% of all entrepreneurs fail in their first year of business ownership. While 30% fail by year two, and half of all Canadian entrepreneurs will fail by their fifth year in business.
Industry Canada wanted to find out why entrepreneurs were failing in business, and they discovered the second most common reason why. Which affected 29% of failed entrepreneurs. Was that they ran out of money in their business.
Therefore, if entrepreneurs could learn how to read their income statements early on in their business. They could use that information to make more informed financial decisions. And can avoid things like spending more money than they have. Which could contribute to them running out of money in their business.
The first thing that Edmonton CPA suggests when entrepreneurs are learning how to read their income statements. Our understanding the four main components on this important report.
The first section is for revenue, and this contains the gross amount of money that they have brought into their business through invoicing their clients, or selling products and services to their customers.
The section below that is called cost of sales, and these are the costs that are directly related to those sales that they generated. If they do not have any sales in their business in that month, they will not have any cost of sales.
The cost of sales are typically the material and supplies that an entrepreneur has bought to produce those products and services. As well as the labour used to produce them. Whether it is staff on payroll, or independent contractors.
Below cost of sales are the general expenses. Which are all of the other expenses that an entrepreneur has to pay in their business. Edmonton CPA says these are going to remain fairly static from month-to-month.
And are all of the expenses that an entrepreneur will incur. Whether they sell products or services in their business or not. Some typical general expenses will include things like rent, administrative staff, utility bills and office supplies just to name a few.
Finally, the last component on the income statement is other income and other expenses. These are for the income and expenses that are legitimately corporate expenses. But are not necessarily related to the business. Such as income brought in from a corporate investment. Or paying corporate income tax.
One of the most important things for business owner to understand. Is that they are salary should be classified in this section. Because it is not a cost of sales, or general expense. But also, so that when it is included in the other expenses category. They will be able to see how well their business is doing. Without clouding the numbers with their salary.
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If entrepreneurs try to make financial decisions in their business without looking at their income statement, they often will make fatal errors according to Edmonton CPA. This is because the income statement will show them exactly what is going on in their business. With all of the revenue as well as all of the expenses taken into account.
Some business owners think that they are going to be able to tell their financial position by looking at their bank statement. And while that is going to be able to show them exactly what is going on in their business at that moment.
What looking at the bank statement will not tell them. Is how much money they have in their business to use. After payments have come out. Or what checks are still outstanding, that have been sent out but not yet cashed.
If entrepreneurs are looking at their bank balance in order to make financial decisions. It might very well be spending money that they actually do not have to use. Which could cause checks or payments to bounce. If they spend that money and it has actually been spoken for for another payment.
Even if an entrepreneur knows all of the different component parts on their income statement. Edmonton CPA says they also should know how to organize this financial statement. So that they can read it better.
The first thing that they should do is ensure that the expenses are listed in numerically descending order. So that they can simply look to the top half of the income statement. And see all of the largest, and most impactful expenses that they have.
If they need to minimize expenses, they should focus on the items that fall above that line. Because even if they are successful in minimizing a lot of the expenses that are at the bottom of the list. That is not going to help them greatly impact their bottom line.
In addition to having it organized in numerically descending order. Been ten CPA suggests that entrepreneurs keep their income statement to a single page at all times. This way, they will be able to look at the statement quickly and understand it.
Since they should be looking at the statement prior to making any financial decisions in their business. Being able to do so quickly and easily. Will ensure that business owners actually do this exercise. So that they can make the most informed financial decisions.
How they can ensure that it is a single page. Is by minimizing the categories that they put their expenses into. Many business owners think that they are being extremely helpful by putting all of their expenses into many different categories. But ultimately, all that does is make their income statement longer. And harder to read.
By ensuring that they are putting their expenses into broad categories. Can help a business owner keep their income statement to a single page says Edmonton CPA. So that they know exactly the information that it is communicating.
So that they can refer to it before making any financial decision. To know if they can afford making those financial decisions. Or if they need to engage in some revenue-generating activities in their business.