Making a profit
Three types of financial statements are prepared by accountants for businesses. The income statement shows the profits and losses of the business over a specific period. The balance sheets report the financial situation of the business at a particular point in time. It is usually the end of the period. The statement of cash flows shows how much profit was made and what the cash was used for.
Profit is something everyone knows. This is the foundation of our economy. This doesn’t seem like a huge deal. You can make more money selling or manufacturing products than you spend on them. It’s not easy, but it is possible. The first thing a profit report or net income statement does is identify the business and the period covered in the report.
An income statement is read from the top to the bottom. Each step in the income statement shows the expense deducted. The income statement also records changes in assets and liabilities. If there is a revenue rise, it could be due to an increase or decrease in assets. An increase in expense lines is a sign that there has been a decrease or increase in assets.
Also known as owners’ equity in a business, net worth can also be referred to. These terms are not interchangeable. Net worth is the sum of all assets fewer liabilities. Owners’ equity is the ownership of assets after all liabilities have been satisfied.
Owners and executives of businesses need to be aware of these changes in assets and liabilities. It is their responsibility to manage such changes. A business’s ability to make a profit is dependent on many variables. These include the management of other assets and increasing cash flow.
Assets and Liabilities
Profits in a business can be made from many different sources. This can be a bit complicated as businesses, just like our personal lives are run on credit. Many businesses sell products to customers on credit. To record the amount owed by customers to the business, accountants use the asset account known as accounts receivable. A business may not collect its receivables by the end of the fiscal year. This is especially true for credit sales that were made near the end.
The accountant records sales revenue and costs of goods sold in the year the sales occurred and products were delivered to the customer. Accrual-based accounting records sales revenue as they are made, and expenses when they are incurred. The accounts receivable account is increased when sales are made using credit. Cash is received by the customer when the cash account is increased. The accounts receivable is then decreased.
Businesses that sell products, services, or goods must pay the cost of goods. Even a service involves expenses. It is the price a business pays to sell its products to customers. The business’s profit is made by selling its products at a price that covers the cost of production, running costs, and income taxes.
The cost of products purchased by a business goes into an inventory asset account. Depending on whether the company has paid cash or credit, the cost of the product is taken from the cash account or added to the accounts payable liability.
Gains and losses
It would be great if business and daily life could be as easy as selling goods and recording profits. Many circumstances can disrupt the cycle and the accountant must report them. Business climate changes, cost of goods, and other factors can cause extraordinary or unexpected gains or losses. Downsizing and restructuring the business can have an impact on the income statement. It used to be rare in the business world, but it is now quite common. It’s usually done to offset losses in other areas and to lower the cost of employee salaries and benefits. This comes with costs, such as outplacement and retirement costs, severance payments, and outplacement fees.
A business may decide to discontinue a product line under other circumstances. Western Union recently sent its last telegram. Telegrams are no longer necessary as communication methods have changed dramatically with the advent of email, cell phones, and other forms. If you are unable to sell enough products at enough profit to justify manufacturing them, it is time to modify your product mix.
Other legal actions and lawsuits can also result in extraordinary gains or losses. You can make an extraordinary amount of money if you win damages in a case against another person. Excessive legal fees, damages, or fines can also have a significant impact on your income statement.
Sometimes, a business may need to change its accounting method or correct errors in financial reports. Businesses must make any one-time gains or losses very clear in their income statements according to Generally Accepted Accounting Practices (GAAP).