Understanding Balance Sheet vs Profit & Loss

 

 

Profit and Loss (P&L) Statement.

 

This report can be updated regularly and shows how much profit or loss a business is making for the time period of the report.

 

A P&L report takes all the revenue that you had during a given period and subtracts all the expenses for the same period and shows what your Profit or Loss for that period was. It is not a measure of your overall business in and of itself as it does not take into account loans, personal deposits/withdrawals, loan payments and similar items that are tracked on your balance sheet. REMEMBER - Loan payments are NOT AN EXPENSE - this is a common misunderstanding we've see. The Interest you pay is an Expense, the Principal which is applied to the loan balance is a reduction to your loan LIABILITY and is reflected on your Balance Sheet.

 

 

The Balance Sheet -

 

The Balance Sheet, is like a snapshot taken at a particular moment in time giving a summary of the overall financial position of a business.

 

The Balance Sheet tracks everything that your business owns, Assets and everything your business owes, Liabilities. It uses these numbers to then calculate your Net Worth which is an indication of the value of your business. The formula is -

 

Net Worth = Assets - Liabilities.

 

Your assets are cash in the bank and things that the company owns. For example your truck(s), trailers, property etc.

You Liabilities are everything that the company owes to others. This can include bank loans, credit card and charge accounts and can include a loan that was made to the business by the owner or other family members.

 

A balance sheet is a two column record of everything the business does, so your entries always need to address both columns of that register. For example you borrow money to purchase a truck. That would be

+CASH and -LIABILITY so the net effect is 0

You then purchase the truck -

+ASSET and -CASH

These transactions have no affect on your P&L statement as they do not represent Income or an Expense which is all that the P&L reports on.

 

Next you make payment on the Liability and this affects both reports. The interest you pay is an Expense so it is reported on the P&L. The Principal is applied against the Liability, it reduces the Liability which in turn increases your Net Worth. Remember above Net Worth is Assets - Liabilities. So if the Liability goes down then the New Worth goes up. So a payment is divided into 2 parts -

PAYMENT $1000

Principal = $800 this is subtracted from the Liability

Interest = $200 this is an expense and is deducted on your P&L report.

This is a common mistake made by owner/operators and fleets. You do not deduct the entire payment as an expense. You can reason that it's an expense since you paid out the money this month, but that is not how it works and if you try to expense your payments the IRS will be knocking on your door.

 

The EXPENSE part of this is called Depreciation and that is calculated based on the original value of the item and the life expectancy of the item. So for our truck, you will Depreciate the purchase price over the expected life of the truck. This 'depreciation' may match the amount of your principal payments, it may exceed or even be less than the amount of your payments. This is a factor of the number of years for your loan and the depreciation period that you use.

 

DEPRECIATION

+EXPENSE -ASSET

So Depreciation reduces the value of the asset, also known as 'book value'. The advantage of high depreciation early on is that it reduces your taxes by giving you a big deduction in the first few years that you have the truck. The disadvantage is that if you keep the truck you will end up with several years of payments with no or a very small deduction to offset the payments. Also if you reduce the book value to zero and then sell the truck you end up paying taxes for a Capital Gain on the sale. This is a subject too complex for a short article so discuss it with your accountant or tax advisor.

 

DON'T HAVE A TAX ADVISOR? Get one. A good tax person will earn their money especially if you get one who knows the trucking industry and knows how to take advantage of the special rules that apply to trucking. Also - if you do get an audit your tax person will represent you and knows the rules and laws so they can present a solid case to the IRS.