60: Your Bank Account Balance Does Not Equal Your Net Income Whether You Are Starting A Business
60: Your Bank Account Balance Does Not Equal Your Net Income Whether You Are Starting A Business, You Are Self-Employed, A Solopreneur, Entrepreneur, Small Business Owner, Remote Virtual Online Bookkeeper, Virtual Assistant Or VA
We are coming to the end of another year and it’s time to really look closely at your finances so that you are prepared when it comes time to file your taxes. Today I am talking about a common misconception when it comes to figuring out what your taxable income is. Many business owners will take a look at their business bank account and think this is the number they will need to pay their taxes on, but this is not accurate, and it causes a lot of problems when it comes down to calculating taxes owed on taxable income, especially if that bank account balance is lower than the actual net income. This can bring about a large tax liability that you may not be ready for. I’ve heard many times that business owners don’t think they will owe taxes because they only have about a small dollar amount in their bank account. This in theory seems like it should be the answer, but you’ll find out today what can cause this number to not match what your true profit and loss or net income amount is. It doesn't matter if you are using a computerized software solution such as QuickBooks, Xero, Wave or Freshbooks or a manual spreadsheet like Excel or Google Sheets, you will still need your net income to prepare your tax return. Whether you are just getting started with your business, you are a self-employed, a solopreneur, entrepreneur, small business owner, remote virtual online bookkeeper, virtual assistant or VA, you really want to pay attention to this episode, so you don’t fall into this same belief. I want to make sure that you are as prepared as possible for filing your taxes and you don’t find any surprises when you figure out what your tax consequences are for the year…
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Show Notes:
We are coming to the end of another year and it’s time to really look closely at your finances so that you are prepared when it comes time to file your taxes. Today I am talking about a common misconception when it comes to figuring out what your taxable income is. Many business owners will take a look at their business bank account and think this is the number they will need to pay their taxes on, but this is not accurate, and it causes a lot of problems when it comes down to calculating taxes owed on taxable income, especially if that bank account balance is lower than the actual net income. This can bring about a large tax liability that you may not be ready for. I’ve heard many times that business owners don’t think they will owe taxes because they only have about a small dollar amount in their bank account. This in theory seems like it should be the answer, but you’ll find out today what can cause this number to not match what your true profit and loss or net income amount is. So, whether you are just getting started with your business, you are a self-employed, a solopreneur, entrepreneur, small business owner, remote virtual online bookkeeper, virtual assistant or VA, you really want to pay attention to this episode, so you don’t fall into this same belief. I want to make sure that you are as prepared as possible for filing your taxes and you don’t find any surprises when you figure out what your tax consequences are for the year…
Welcome Back…You grab your check register, or you take a peek at your business account online, and you see that your balance is relatively low. Although you are not happy with the amount of money you have, you are somewhat hopeful that you won’t have to pay too much in taxes this year due to the low balance in your bank account. Well, I’m sorry to tell you that this is not the way you decipher what your taxable income for the year will be for your business, but I am glad that you are here with me today so that we can break down why this is incorrect, and you’ll have the knowledge to know where you need to look instead.
First, we are going to start off with what your profit and loss or net income is. Both terms are used interchangeably and regardless of which term you use, you will arrive at the same answer. When you are calculating your profit and loss or net income, you simply take the total of all your business income or revenues and subtract all of your business expenses. This amount tells you if you have a net profit or net income if you have a positive number, or you may have a loss if you have a negative amount. This is the number that you will use on your tax return to calculate the amount of your tax liability.
Next, let’s take a look at your bank account balance. This is generated by adding up all your deposits and subtracting all of your withdrawals from your bank account. It is the amount of money you have in your bank account as of a certain period of time. The best way to calculate this number is to make sure you are reconciling your bank account to ensure you are taking into consideration any withdrawals or deposits that have not cleared your bank.
If you are still wondering why these two numbers may be different, let’s dig a little deeper. One of the reasons these numbers may be different, and a reason I see most frequently is when a business owner takes money out of the business for personal reasons. Think about this for a minute. If you are taking money out of your business for personal reasons, it would not be considered business income, and it is not considered a business expense either, right? When you take personal money out of your business, this would be considered a draw and does not show up on the profit and loss or income statement at all. You would record these amounts on your balance sheet in your equity section since you are taking equity out of your business. You will see your business bank account go down for the amount of money you take out of your business personally, but your net income or loss will not change. If you have a situation where your bank account balance is lower than your net income, this could be one reason for the difference.
Another reason you may be seeing a difference may depend on if you are looking at an accrual or cash basis report. I’ll give you a quick description of each and then I’ll explain more about why this could make an impact on the difference between your bank account balance and your net income. If you are looking at a profit and loss report that is accrual basis, this means that it is taking into consideration your accounts receivable and your accounts payable. Your total income is calculated on sales you have made but may not have received payments on yet, and your expenses are calculated on bills you have received, but you may not have paid them yet. If you are looking at a cash basis report on the other hand, there is no accounts receivable or accounts payable taken into consideration, which means that you are only looking at income that you have received payments on and expenses that you have already paid. When you think about these two reports, you could have completely different amounts for your net income if you have a high amount of receivables you need to collect from your customers or you have a high amount of bills that you have not yet paid. If you are comparing an income statement prepared on the accrual basis, it is taking into consideration income that you have not received yet and would obviously not be in your bank account. This can cause a significant difference in these two amounts.
Loan payments are another way that your bank account balance and your net income can be different. When you take out a loan, your loan is recorded as a liability on your balance sheet and when you make your loan payments, this liability on your balance sheet goes down by the principal amount when you make each payment. The only amount that would be reflected on your income statement would be the expense portion of the interest you are paying on your loan. In contrast, you will see the full amount you are paying on your loan decrease in your bank account balance.
There are many other reasons why your bank account balance may not match what your profit and loss or net income shows, but I wanted to jump into a few of the most common scenarios on this podcast. Most importantly, I want you to understand that looking at the balance in your bank account will not give you a true profit and loss or net income or net loss amount. Your bank account is essentially just capturing the money coming in and going out of your bank account and there are times when the movement of these funds does not impact your profit and loss. When it comes to this time of the year, you really want to be looking at your net income or your profit and loss report to see how your finances are looking and to make decisions on any tax planning strategies for the year. I know this can be a complicated concept and it is a misconception that many business owners make. Please know that I am here for you if you have any questions about this or any other bookkeeping topic. You can contact me by going to www.FinancialAdventure.com/Contact-Us - I’d love to hear from you, and I personally respond to all my emails. I’ve been getting a lot of feedback and questions from business owners just like you and I decided to hold a workshop to help you answer your questions and to cover 7 Mistakes To Avoid In Your Business. In this workshop, you’ll learn the secrets successful entrepreneurs have overcome to raise the level of success in their business and master their small business finances. You can register for this workshop by going to www.FinancialAdventure.com/workshop. I’m looking forward to seeing you there. I’ll post links for these and other valuable resources for business owners and bookkeepers where you are listening to this podcast and in the show notes.
And, you know I’m going to ask…what’s at least one thing you will take away from this episode that will help your business succeed and grow your bottom line? If you need some accountability, join our PRIVATE Facebook community and post your action item, we’d love to support you.
