Peering Beyond the Net Profit: Unveiling Hidden Expenses on the Balance Sheet

So imagine this scenario: You have spent a whole year working your butt off in your business and you finally found time to get all of the receipts, bank statements and credit card statements to your accountant to file taxes. They have a meeting with you and give you some good news! They say, “Congratulations, looks like you made $40,000 in net profits this year!” You look at you and your better half both look at each other with a skeptical stare. Where is that $40,000? 

This is why finding better bookkeeping is so beneficial because too many business owners are not told that your “net profits” are not your “true profits.” Just because your net profits say that you made $40,000 over the whole year, doesn’t mean that you actually end up with that much money at the end of a year. It was spent somewhere, and that’s what this article is about. Below, you’ll find five of the most common areas that businesses have money slip through their hands and are spent throughout the year.

Loans, Interest & Credit Card Expenses

It takes money to make money, right? For many small business owners, they decide to take out a loan on their business to get things started. Maybe they have work vehicles or equipment they need to purchase too, so those are more loans. Soon enough, if business owner aren’t too careful, large sums of money are being shelled out each month on interest payments, credit cards and loans that have slowly stacked up overtime, without any end in sight! Fluctuations in interest rates further exacerbate the impact, leading to volatility in net profit figures.

Consider a real estate development company financing its projects through debt. While interest payments on loans reduce taxable income, they also diminish the net profit figure, potentially masking the company’s operational performance. It’s wise for business owners, when they sign on to debt obligations, to already come up with how they get out of this debt as soon as possible.

Owner Draws and Equity Withdrawals

In small businesses or partnerships, owners may take draws or withdrawals from the company’s profits. These withdrawals, while not expenses in the traditional sense, reduce the retained earnings of the business and impact its net profit figure. Often, these draws are used for personal expenses or investments outside of the company.

For example, in a family-owned restaurant, the owners might regularly withdraw profits from the business to cover personal expenses. The reason why business owners forget about these expenses is because they aren’t listed on the Profit & Loss statement. Since they don’t have their personal income listed on salary or through payroll, it doesn’t show up as an operating expense.

This is why in our belief, we recommend almost every small business owner should be on payroll. That way, you are baking into the business the ability to pay you as the owner, and confidently know that your business can support you, while staying profitable!

Organizational Restructuring and One-Time Charges

Corporate restructuring, mergers, acquisitions, or divestitures often entail one-time charges that affect the bottom line. These charges may include severance payments, asset impairments, or write-offs. While non-recurring, these expenses can distort the net profit figure for the period in which they occur.

For instance, a company undergoing restructuring to streamline operations might incur significant expenses related to severance packages or asset write-downs. Although essential for the company’s long-term viability, these expenses can obscure the true underlying profitability of its core business activities. 

We would also include any significant changes to how the company is run that can’t clearly be shown in a financial statement. For example, dramatic changes in personnel don’t dramatically change the cost of payroll, but can greatly decrease the ability to complete work and therefore, collect more from customers.

Purchase of Assets and Depreciation

Investments in tangible assets, such as machinery or equipment, involve upfront costs that are amortized over their useful lives through depreciation. While these expenses don’t entail immediate cash outflows, they reduce the value of assets on the balance sheet over time, impacting profitability. A manufacturing company investing in machinery spreads the cost over its expected lifespan through depreciation, but this is tricky because you know that you shelled out lots of cash at the beginning. 

Accounts Receivable and Bad Debts

This is a big one for many of our business owners. Poor management of accounts receivable (A/R) can create giant cash flow problems. A/R represents amounts owed to a company by its customers for goods or services provided on credit. However, not all receivables are collected, leading to bad debts that must be written off. These uncollectible accounts reduce the company’s net profit by reflecting the loss incurred due to non-payment.

While net profit serves as a vital metric for assessing a company’s financial performance, it’s crucial to recognize that it may not provide the full picture. Beyond the surface lies a myriad of hidden expenses, from interest payments on loans to owner draws and restructuring charges, each influencing the bottom line in its unique way. These are often found in the balance sheet!

By understanding and accounting for these hidden expenses, investors and stakeholders can gain deeper insights into a company’s financial health and make more informed decisions. Whether evaluating the impact of debt financing, recognizing the compensation of owners, or assessing the effects of one-time charges, a comprehensive analysis of the balance sheet unveils the true profitability of a company amidst the complexities of modern business. This is why having better bookkeeping helps you truly depict your business’s well-being!

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