Around Australia, businesses prepare their EOFY spreadsheets to check their financial position as well as plan for their tax, however understanding the data and interpreting the results can leave the average business owner confused. Certain spreadsheets reveal different aspects of the businesses financial health, but what purpose does the balance sheet and the income statement serve – and which document is the most important?
The Balance Sheet
The balance sheet is usually prepared at the end of financial year (EOFY) to show management, creditors and possible investors information on where the business earns revenue and how it spends its revenue. The balance sheet shows the current assets and liabilities of the business. At EOFY, the balance sheet gives a snapshot of what assets the business owns and its liabilities, and is sometimes referred to as the business’s statement of financial position.
What Does A Balance Sheet look Like?
A typical balance sheet details assets in a column on the left and the liabilities in a column on the right. Assets are resources that the business owns and be can tangible items such as vehicles, real estate, computers, office furniture and other fixtures. Intangible items include intellectual property, pre paid insurance, brand recognition, patents or trademarks.
Business assets are divided into two sections: current and non-current assets. Current assets are assets that will be turned into cash within one year, such as securities, inventory and debts. These assets have a short value.
Non-current assets are longer term assets and are less able to be liquefied into cash, which would take more than one year. The business usually doesn’t intend selling or converting these assets into cash. Non-current assets include property, buildings and capital equipment.
The business’ liabilities are categorised as current, non-current and equity. Liabilities are the amounts owed by a business at any one time.
Short-term liabilities are obligations the businesses faces which are expected to be paid off within one year. This includes sales taxes, payroll taxes, loans and mortgages payable.
Long-term liabilities are expected to continue for more than one year. These types of liabilities include loans and/or mortgages payable.
Liabilities vs Expenses
There is a difference between liabilities and expenses. Business liabilities are regarded as money owed by a business to purchase an asset, such as a vehicle, property or capital equipment that ends up being a loan.
An expense is an ongoing payment for goods or services with no tangible value. Expenses are used to generate revenue. Some expenses are general, while others relate directly to sales.
Liabilities appear in the balance sheet. Expenses appear in the Income Statement.
The income statement is used to report the financial performance of a business. This is also known as the profit and loss statement and focuses on businesses revenues and expenses during a nominated period. An income statement provides valuable insights into a business’s operations, the efficiency of management, under-performing sectors and the businesses performance within industry standards.
The income statement focuses on four main areas: revenue, expenses, gains and losses. It does not differentiate between cash and non-cash receipts. It details sales, net income and earnings per share and gives an account of how the net revenue is turned into profits or losses.
The net income is the revenue plus gains, minus the expenses and losses and can be seen in this equation:
Net Income = (Revenue + Gains) – (Expenses + Losses)
Revenue and Gains
Operating revenue is generated by a business’ primary activities. This can be goods or services and can be compared year over year to assess the health of a business and its operations. Operating expenses are different to non-operating revenue which occurs from infrequent, unusual, or one-time events.
Non-operating revenue is revenue a business earns through secondary or non-core activities, which may be from bank interest, rental income, royalty payments.
Gains indicate the net money made from the sale of long-term assets. These are from one-time sale of assets such as the sale of a vehicle, capital equipment, buildings or a subsidiary business.
Expenses and Losses
Expenses occur from operating a business. Sometimes expenses can be written off at tax time.
Primary expenses are incurred as a part of the normal running of a business. They include the cost of goods sold (COGS), selling, general and admin expenses, depreciation, wages, sales commissions, and utility expenses. Primary expenses offer insights to how well a business core function is performing.
Secondary expenses are those linked to non-core business activities such as interest paid on loan money. These type of expenses indicate how well the ad-hoc, non-core expenses are managed.
The main use of an income statement is to detail the profitability and business activities to management and stakeholders and provides insights into business performance when compared against peers. Managers or business owners use information from the income statement in determining which direction the business should grow. This growth could form expansion into new territories, development of new products, increased production, the sale of assets or shutting down of a non-functioning department.
Both the balance sheet and the income statement provide valuable insights into EOFY business performance. The EOFY is a key time to review your business performance and make decisions that impact the future strength and growth of your business. A knowledgeable accountant can prepare your documents and provide insightful, valuable advice. ITP Accounting Professionals have helped Australian businesses for 50 years with bookkeeping, account management and professional financial advice. Speak with an ITP accountant about your business today.