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E-Myth – “Why most small businesses don’t work & what to do about it”

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Virtual CFO | Using Income Statements To Make Financial Decisions

More often than not, business owners are going to need to make financial decisions in their business before they have their year end financial statements ready to review says virtual CFO. Many business owners believe that they are able to make their critical financial business decisions based on reviewing their income statements, but this is not best practices. The most important information exists on the businesses balance sheet. The reason why many business owners donít use the balance sheet in order to make important financial decisions, is because they donít understand how to read it, therefore they use the income statements to make financial decisions, that are not necessarily in the business is best interest. Half of all entrepreneurs end up closing their business before their fifth year, and 29% of them say that the reason their business closed was because they ran out of money. Being able to make better financial decisions, can help business owners avoid this reason why many businesses close.

When the reasons why business owners should be looking at the balance sheet first, not only does it have the more important information, itís also a lot easier to catch mistakes on the balance sheet and on the income statement. Virtual CFO says that businesses should understand that there is a higher chance that there is mistakes on the interim financial statements simply because the interim financial statements have not been prepared by their accountant. Learning how to review and understand balance sheets can help business owners first verify if there are any errors and fix them, and then go on to make better financial decisions.

When business owners are reviewing their balance sheets, ritual CFO says that another best practice that they can follow is looking at their six month comparative balance sheet can be a powerful tool to catch errors. The reason for this is because itís going to be much easier for businesses to see mistakes or any variances looking at six months at a time. If business owners see something that looks different in one month than another, they should investigate that because itís possible that it could be an error.

Entrepreneurs should also understand when there reviewing the cash on their balance sheet, but itís going to look different than the cash in their bank statement. The reason for this is very simple says virtual CFO, because the amounts given on the balance sheet include the all payments that businesses have made, and all receivables that are scheduled to come in. However the bank statement is going to show everything that has already cleared and has already come in. If business owners are waiting for a check to clear, or payment to come in thatís not going to be reflected in the bank statement. A business owner should make their financial decision based on whatís in the balance sheet, because looking at the bank statement is going to be a misrepresentation of what the true balance is.

Income statements are often a lot easier for business owners to understand says virtual CFO, and because of that they tend to make important financial decisions based on the information in an income statement. This can create problems for entrepreneurs, because the most important information for business owner to consider when making financial decisions, exists on the balance sheet. Business owners should understand that there could be errors on their interim financial statements, and there were easily detected when reviewing balance sheets versus income statements. Since many entrepreneurs face cash flow issues in their business, one way that businesses can help themselves avoid cash flow problems is by making financial decisions based on the best information they have on hand which would be using their balance sheets.

Thereís a few things that business owners keep in mind when they are reviewing their balance sheets for errors, and the first thing is looking at their credit card balance from one month to the next. This is most easily done when business owners are looking at six month comparative balance sheet other than each individual month of time. If there credit card balance stays the same from one month to the next, this can indicate there has been an entry error. Business owners can review all of the different entries that have been made on the balance sheet, to see if the credit card charges have not been added yet, or if theyíve been added somewhere else instead. If business owners are only looking at an income statement, this is the sort of error thatís not going to be obvious.

Business owners should also watch out for their loan balances says virtual CFO. And that there loan balances should be decreasing every month. This is again much easier to see if businesses are looking at their six month comparative balance sheet instead of one month of time. If the loan balance is not decreasing each month, it could mean that the business owner did not like the loan payment which is important to find out says virtuals CFO. Or that the loan amount was excellently applied to another account which could be not only because errors here but creating errors in other areas of the balance sheet. For example, if the loan balance amount was entered into the profit and loss area of the balance sheet, it will end up showing that the business made less money than they actually did make.

In addition to reviewing their balance sheet for errors, entrepreneurs should also look at all of the individual transactions that have been included in their shareholder loan account. This is extremely important, because if there is anything that shows up in their shareholder loan account that should actually not be there, business owners are going to want to take note and remove that from their accounts. Otherwise, a business owner can end up paying personal taxes on corporate expenses says virtual CFO. This is extremely important for business owners to avoid in order to minimize the amount of taxes that they pay.