By Sandra Taylor-Sawyer: CNJ business columnist
In order to make good management decisions, the usage and regular review of monthly financial statements are necessary tasks. The two basic financial statements are the balance sheet and the profit and loss (income) statement. The profit and loss statement is the focus for this article.
The income statement consists of all income derived from the sale of products or services, including commission received. In New Mexico, the gross receipts tax (sales tax) rate will be multiplied by the income received. The computed amount represents the tax due to the state. The gross receipts tax is the only tax paid using total income received.
Another main area aside from the income received is the allowable expenditures of a business. Allowable is an important word. All cash outflow of a business is not automatically an expense.
The Internal Revenue Service defines a business expense as a necessary and ordinary cost that is helpful and appropriate for the business. Expenses are further categorized in four areas: cost of goods sold, capital expense, deductible expense and personal expense.
Cost of goods sold reflects the cost of inventory sold.
Capital expenses are monies used to purchase assets such as property, vehicles, or equipment. The cost of these assets is expensed out over the life of the asset by using a method called depreciation.
Deductible expenses reflect costs such as wages, utilities and advertising. The deductible costs are expensed within the year of occurrence or when paid, depending on the accounting method used (accrual or cost).
Personal expenses are not a common allowable expense for a business.
After the cost of goods sold and allowable deductions are subtracted from income received, the difference can be a net gain or a net loss. This is where the tax obligation of a business will be determined. If there is a gain, the business owes tax; if there is a loss, there is not a tax obligation.
Human nature dictates a celebration when there are not any tax obligations, which is OK until a loan is needed or it is time to sell the business.
When a lender reviews a loan proposal, the income tax return is a very important document that will be reviewed. A consistent loss from year to year will not conclude in a favorable outcome.
The loss demonstrates the business has substantial issues and may be dying a slow death. If a loan is given, it will be obtained at a high cost, either by a high interest rate or waiting another year or more for approval.
The other drawback in having a continuous net loss is when one tries to sell the business. There are not many individuals who are willing to purchase a business with a record of losses. The old saying “pay now or pay later” rings true.
Regardless of the type of business, nationality of the owner or location of the business, all entities (business or personal) should pay a fair share of taxes, which means income and expenses must be recorded accurately.