What are Financial Statements?

When we talk about financials, we are talking about two specific reports: The Income Statement, also known as the Profit & Loss, and the Balance Sheet.

Income Statement: This report shows how well your business performed over a stretch of time. It shows what money the business earned, as well as all the business’ expenses for the period. At the bottom of the income statement is the “Net Income”. Put simply, the net income (or net loss) is what the business made (or lost) after all expenses have been paid.

What Halon Needs: For tax return purposes, Halon needs your income statement for the whole year (January 1st – December 31St).

Balance Sheet: This report shows what the business has at a particular point in time. At the top, it has all the business assets: amount in the checking account, cash on hand, accounts receivable, etc. Assets are items that the business can claim ownership to. Next are the liabilities –credit card balances, accounts payable, loans, etc.

Liabilities are items that the business “owes” to others. At the bottom is the equity section. Equity is the trickiest part of the balance sheet. It has items like: contributed capital, shareholder distributions, retained earnings, and net income from the income statement. If you don’t know your equity amount, it is always company assets minus company liabilities.

What Halon Needs: A company balance sheet needs to be prepared for the last day of the year (December 31st).

There are two methods of preparing financial statements: one is the “cash” method, and the other is the “accrual” method. The only difference between the methods is the timing of when income and expenses are recorded.

Cash Method: With the cash method, revenue is only counted when received, not when billed. Likewise, expenses are only counted when they are paid, not when they are ordered or received.

Accrual Method: This is the opposite of what is detailed above; income is recorded when it is billed, not when it is paid, and expenses are recorded when they are ordered, not when they are paid.

It is important to account with the same method from year-to-year. There is no pick and choosing a method that suits a business better for a particular time. When you pick a method, you must stick with that method unless you get permission from the IRS to change methods.

What Good Financials Should Look Like

Good, accurate financials are essential for a good tax return. As the saying goes “garbage in, garbage out.” Not only that, but the IRS may audit a tax return, and good bookkeeping will be one of the best tools to defend the business. So, what do good financials look like? Let’s start with the income statement.

 First, the income statement needs to be prepared for the whole business year, which in most cases is January 1st through December 31st. Second, the numbers should be presented in total by revenue and expense type, for the whole year. Here is an example of how that should look:

You can see the numbers aren’t separated out by month or by vendor, but in aggregate for the whole year, separated out by revenue type (one in this case, sales), and expense type. There doesn’t need to be any detail beyond expense type. Below is an example of what your income statement shouldn’t look like:

Another common issue with the income statement is payments to owners being reported on it. If a shareholder or partner received a distribution payment, it should be recorded in the equity section of the balance sheet, NOT an expense on the income statement.

If there are payments to partners and owners on the income statement, remove them and put them on the balance sheet. Also common are loan payments. When the loan is received, it is not recorded as income, but rather increases the company’s liabilities on the balance sheet. Likewise, when a loan is paid back, it is not an expense; it just reduces the loan balance on the balance sheet. Interest paid on that loan however can be expensed, and that is the only loan-related item that should be reflected on the income statement.

The MOST common mistake on the income statement is the expense of fixed assets. Per the IRS, any purchase of equipment over certain amounts ($2,500 for 2016) must be put on the balance sheet as a “Fixed Asset”, and depreciated over time; not expensed all at once. The depreciation expense is the only expense item related to that purchase that will be on the income statement.

This applies to most large business purchases: vehicles, buildings, equipment, furniture, etc. If there was a large purchase that wasn’t inventory, supplies, or repairs, remove those expenses from the income statement and put them in the asset section of the balance sheet. If you are worried about not getting credit for the purchase in the year you bought it, don’t! There are numerous methods to getting full credit for the purchase, but they all require the purchases to be listed on the balance sheet. Below is an image of how it should look (in red):

The depreciation expense that gets listed each year will be different, based on how many purchases you made during the year, and purchases made in prior year. Halon will calculate the depreciation expense in current year for you.

Balance sheets can be one of the trickiest financial statements to prepare, but it is also one of the most crucial to get right. Everything listed on the balance sheet is “as of” a certain date. For tax returns, the balance sheet must be prepared as of the last day of the year, in most cases December 31st.

Look at business checking and credit card statements as of December 31st, and put the balances in the asset and liability section respectively. When everything has been entered as of the last day of the year, it is important to know that the asset balance should equal the liabilities balance PLUS the equity balance. If they don’t equal, there is something wrong in the balance sheet.

Creating Financials

In QuickBooks Desktop

To create the income statement in QuickBooks desktop, first click “Reports” at the top, then “Company & Financial” and “Profit & Loss Standard”

Once created, make sure the dates are from the first day of the year, to the last. Usually from 01/01/20XX to 12/31/20XX. Also, make sure the method shown at the top left of the report is the correct accounting method used on the prior year tax return. To change the method, click “Customize Report” at the top left, and select the basis you would like to use.

To print a PDF, click “Print” at the top of the report and “Save as PDF”.

To create the balance sheet in QuickBooks Desktop, click “Reports” at the top and “Company & Financial”, just like the income statement, except here you will select “Balance Sheet Standard”.

Make sure the accounting method at the top left of the report matches the method on the income statement, and it is the same method that has been used in prior years.

To print a PDF, click “Print” at the top of the report and “Save as PDF”.

In Excel

If you are using Excel, it is important to aggregate the whole year’s info into one column, with revenue at the top, expenses in the middle, and net income at the bottom. Below is what the ideal Excel income statement should look like:

Below is what the ideal balance sheet should look like:

If you aren’t sure if you’re bookkeeping and financials are correct, but you have all the information entered, Halon offers CPA bookkeeping review services. Halon will review all the information and make sure it is formatted correctly for the tax return. Halon also offers CPA meeting time if you aren’t sure about certain bookkeeping or tax related items, and wanted to discuss your situation. We are always happy to help!

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