The Bank account theory VS The Financial statement theory
The number one question an accountant will get from a business owner is “how can I be making a profit” and for a good reason. As we emerge from the economic downturn, it is one of the most important questions business owners should be asking themselves and thinking about.
When I look at this as a CFO, I look at it as two different theories. One is the bank account theory that many business owners will run their businesses on, and the other is the Financial Statement theory.
The bank account theory goes as follows ‘if I have money in the bank, I assume there is profit on the books. No money, then there must be a loss on the books’
From a CFO and accountants’ perspective, this is only one aspect of running your own business and cannot be the only aspect you consider when analysing your profit and cash flow.
Many small businesses fall victim to the bank account theory, especially when the economy goes through a rough patch. No business wants to shut its doors. Instead, they will seek loans from the bank and make purchases for the business on their credit card.
This is fine at first glance and can be a lifesaver for any business if done correctly.
The issue affecting these businesses is not taking out loans but rather when it comes to making the repayments.
Once your business begins to pick back up, and the profit starts rolling in again, it is a wonderful feeling, but then you remember, you have those loans and credit payments you need to start making.
This is where we get into the financial statement theory and how a CFO can help you thrive and grow that profit without stressing about repayments and whatnot.
When you took out the loan or the line of credit for your business and expenses, the first thing you should have done was capture and record these expenses on your financial statement for the year.
When you pay back these loans, you are NOT receiving an expense benefit on your financial statements or income tax returns, meaning money used to pay for loans is NOT captured as a business expense.
An example of this would include a business owner having a tough year, business is slow, so they decide to take a loan out. The following year, business picks back up, so they can start paying back their loan.
They make a considerable repayment of $12,000 but count this as a loss in their books. However, as an accountant, I would consider this $12,000 part of your overall profit, even though it decreased the bank balance.
This all may sound a little confusing; trust me, I get it. That is why accountants and CFOs exist to help you understand and manage your finances so you can accurately understand and managing your profit margin and overall cash flow.
Your accountant or CFO must give you an accurate statement of revenues and expenses along with a balance sheet. All of these financial statements work together and, when understood, can help you improve to increase overall profit.
If you are tired of following the bank account theory and want to learn more about the financial statement theory and how you can improve your overall financial side of your business, please send me any questions you may have.