Edmonton CPA | Why Understanding Income Statements Is Important
If business owners do not understand how to read their income statement says Edmonton CPA. They and up making poor financial decisions, that can result in them not being able to afford to pay their bills or pay their employees.
In fact, industry Canada that a survey and found that 29% of all failed entrepreneurs said running out of money was the reason why they were not successful in business.
By learning how to read their income statements. Business owners can be far more likely to make more informed financial decisions. That can help them avoid this common business problem.
If a business owner reviews their income statement prior to making any financial decision. Whether it is paying bills, paying staff or making purchases. They will be able to understand they have the finances in their business to make this decision. Or if they need to generate more revenue in order to be able to afford to do that.
The first thing that business owners should learn when it comes to reading their income statement says Edmonton CPA. Are the four sections on an income statement.
The first section is revenue, and this is all of the amount of money that the entrepreneur has brought into their business through invoicing their customers, or selling their products and services.
While a business owner might bring in more income to their business through other means. That does not belong in this section. Such as income from a rental property they might own, or income from investments the corporation might own. This revenue is strictly business related income.
The second section underneath revenue is cost of sales. And the best way to understand what is involved in the cost of sales says Edmonton CPA. Is all of the expenses that a business owner has because they have generated these sales. If they have no sales they will have no cost of sales.
Typically the costs that will go into this section will be materials and supplies needed to be purchased to produce those products or services. And the labour needed to produce them. The labour can be salaried staff, or independently hired contractors.
The third section below cost of sales are general expenses. And these are all of the rest of the expenses that an entrepreneur will have in their business. If a business owner has no sales whatsoever, these are all of the rest of the expenses that they will pay just open the doors to their business.
These costs are typically considered the rent or mortgage of the office space, equipment leases, utility bills and office supplies to name a few. And while administrative staff salaries belong here. Some business owners are confused as to why some of their staff is an cost of sales and why some are in general expenses.
Ultimately, it boils down to what is paying those staff members to do. If the staff is working on creating products or delivering the service. They are cost of sales. And if an entrepreneur would still need those employees work on administrative duties, even if they had no sales. They belong in general expenses.
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So many entrepreneurs struggle with understanding basic business financial literacy says Edmonton CPA. Especially when they first open the doors to their business. The problem with this is since they are running their business as they are learning this. If they do not learn fast enough, they may make critical errors that cause them to go out of business.
This is why Edmonton CPA recommends that entrepreneurs learn as quickly as possible help to read and use their income statement. So that they can make more informed financial decisions in their business. By reviewing this statement before making any financial decision. Ensures that an entrepreneur will be able to make a better decision. And can avoid things like running out of money in their business.
One of the first things that entrepreneurs should understand is that their income statement should be organized in numerically descending order. So that the most significant expenses can be listed at the top of their statement.
This way, if they want to minimize their expenses., All they have to do is look at the top half of the report to find out what is worth their time and effort to minimize. The most typical expenses that will be at the top half of their income statement will be the rent of their office space, administrative staff and amortization of their equipment.
At the bottom of their statement, will be things like utility bills, cell phone bills, office expenses and bank charges. And while a business owner may want to minimize those expenses if they can. Edmonton CPA cautions business owners to not spend a lot of time minimizing these expenses.
The reason why, is if an entrepreneur is successful in minimizing them significantly. That is still not going to be very impactful to their bottom line. Make it not an activity that they should spend a lot of time doing.
Another thing that business owners should understand about their income statement is that the owners salary should not be in direct cost or general expenses. The reason why, is because a business owner should be able to look at the revenue, cost of sales and general expenses.
In order to understand how well off their business is doing financially. Without having their salary in that report. Especially because the amount of money that an entrepreneur takes out is not an expense of the business. But more of a tax strategy or lifestyle choice.
And if an entrepreneur is ever going to be applying for financing or alone either with any financial institution or with their bank. The bank will need to know how much money business is doing independent of the business owners draws or salary.
And if an entrepreneur has not split them out ahead of time, they might be denied alone. Because their business does not look like is doing well. When it could be doing extremely well. But a business owner is taking a salary because they can.
This is why learning how to organize the income statement and how to read this report is extremely important. And should be one of the first things that any entrepreneur does in their business.