Creating Your Income Statement
I'm gonna go on to income statement. This is the first time, and this is the problem with accounting. And I ran into this when I wrote my books. You look a dummies book, Any dummies book. It's very, very standardised. So when I wrote my dummies books, I had to do something that I don't like to do. And that is changing. Conform because there is a recipe for doing this to have a successful dummies, books and one of the things in the Dummies book our conventions, where you explain terms. And unfortunately, this is the first area where we have multiple terms, meaning the same thing. And in a dummies book, you have to explain to the reader revenue and sales. Mr. Reader, Mr Mrs Reader mean the same thing for this course to revenue and sales mean the same thing, which is why I put it in parentheses. So let's define it. Income statement is the revenue or sales your company generates less the expenses you incur, and that equals that income or profit. I'm going to use netter net income or profit...
interchangeably. Also read it again without interrupting revenue and sales. Your company generates less the expenses you incur equals net income or profit. And I should also say that a balance sheet is for a period of time, a month, 1/4 a year, a period of time. Again. If you try to create an income statement for January 22nd you'll get an error message. Has to have a from an A to date in there. Okay, Income statement. I said it a little bit different way on this slide. Revenue and expenses equal net income. Or you can switch sales and expenses equal profit. Right now, I'm looking at my preview cause the next thing is really important. Um, let's talk about a couple things within that formula just to just to connect to the balance. Shoot. Okay, Does revenue necessarily mean that you've collected the money? In other words, can you have revenue without collecting any cash Yet? Do you think based on what we talked about? The answer is yes. You can have revenue or sales without collecting the money on those revenue or sales, which means that your posting revenue to this income statement and on the balance sheet there's no cash. Okay, in the same way you can have an expense without writing the check yet so that you have an expense on the income statement. But you haven't written a check yet for the utility bill. Okay, What I'm starting to go into is the disconnection between cash and your accounting records. There is a disconnection. In other words, they are not the same thing. Okay, I'm gonna throw in one other financial statement that is not in the power point, but that is important. This is something you're going to need to get to pretty soon in your business. And I didn't put it in the power point because it's a little farther down the road, but I'm gonna medicine. It is called statement of cash flows statement of cash flows. So if you can imagine, you're literally going to take your checkbook and you're going to classify deposits and checks into three categories. Okay, Three categories. Statement of cash flows. The first is cash inflows and outflows from investing, which is buying assets to use in your business, like inventory and selling those assets. So if you buy inventory, that is a use of cash for investing because that you're buying an asset. If you sell your truck that you use in the plumbing business you were. That is a cash outflow. That's a cash inflow from investing, cause you're getting paid for the truck. See what I mean? Any changes in your assets, cash inflows and outflows get grouped and do cash flows from investing. And again, I wanted to do an overview of this one. Even though it's not on the slide because you need it. You're gonna need it pretty quickly in your business. Cash flows from financing, raising money to run your business. You issue stock That's an inflow from financing. You pay back a bank loan. That's a cash outflow financing okay, so casual from financing. And then everything else gets put into a category called Cash Flow from Operations, which is just the day to day running of your business. Ah, client pays you. That's an inflow from operations. You write a check for the four payroll. That's an outflow operations. So the three categories are investing, financing and operations. So what you do every month when you guys get a little further down the road, The great news is that QuickBooks and similar software may even do this for you. If you're doing the income statement in the balance sheet, that data will get dumped into this cash flow calculations. Okay, If you're doing it manually, you're literally taking your checkbook and saying Which of the three categories do all these inflows and outflows go to? The purpose of the report, obviously, is to find out where all that cash is going. Where is it going? Okay, um, another thing that I do, How many jobs does he have? Does he keep any of them? Who would hot He's on hirable. He's this guy isn't hirable if you're kidding. So one of the things I also do for a climate matters that go on the road and I explain on investment product that they manage to investment brokers, which is a lot of fun. I'm going to use the next week. Hopefully won't be zero degrees There. We were talking about Houston in the production meeting, so I gotta go to Houston. It's a weird existence because I literally fly in the day before I show up at a meeting. I smile and I shake hands with people. I'm a nice guy, and I stand up when I talk for 30 minutes and I leave now. Here's why. It's hilarious. It's hilarious because everybody else there is a walk. Ah, brilliant technical walk the last time where I don't even know where I waas The lady who was introduced before me to speak worked for Goldman Sachs and she had an MBA from Columbia University and she was Columbia University in New York and she was working on her PhD One guy, the guy. One time the guy started before me What had a PhD in math. So I stand up and when I do my thing, I talked to people just like I talked to you, you know? And I usually say the smart people are before and after me, But let me just explain this to you in terms of your client can understand because after all, isn't this all about explaining to your client and all the brokers smilingly neither head and then I do my 30 minutes and get off stage, and then somebody else comes up and talks about it much other stuff that I don't understand. And then I fly home. That's pretty fun. There are on Lee, and this brings us to, ah point about equity before I leave it. Which I skipped it. I'm gonna come back to it. There's only two ways to raise money to run your business. Only two ways. Dead or equity. Those are the only two ways now, you know, financial companies make this really complicated, But think about it. There's really only two ways debt and equity debt, meaning that you can borrow money and you have creditors equity meeting that you sell ownership. And that's really it. Okay, debt and equity. I say that because we were talking about casual from financing. Do you issue debt? You get money. That's an inflow. You issue stock, you get money. That's an inflow, right? So that was my attempt to tie cash flow activity with how you raise money to run your business. Now let me go back because I think it's important careers and talk about Well, what about Angel and VC investors? That's equity. That's ownership, however, but the tough nut to crack there is. What are the angel investors in the V. C. People asking of you? In other words, how much ownership do they get? How much of the prophet do they get? Do they get their profit before you get any profit? So there's a whole conversation that needs to happen on that. Okay, Um, a friend of mine was the CFO of a company that was bought out by a private equity company. And here's experience These people were really demanding, really demanding. So you need to consider that How much of my ownership in my giving away, How much of the prophet do they? I didn't want to leave without making that point. So I have two questions. One is around giving shares of your company because I have corporations sequel, Corpse to your employees and how does that look? And then to during the lifecycle of some businesses will be times when you actually personally loan your business money and what does that look like? Two great points. And this is important for this course because what was just described was getting assets to run your business, and also an extremely important point for creative folks is how do you reward people to keep him? Because the asset for creative businesses, the people, right, if the people talented people leave, you got nothing. So this is Jermaine to use a big word to this course. Okay, first of all, rewarding employees generally, when you give stock to employees that is usually unexpended to the business, it's a compensation expense, and it's normally tied to you've heard term golden handcuffs. We heard that in business, you gotta work at the company a certain number of years to get this stock. Okay, so that's how that works. So when you put money into your business, let's say you put in $10,000 in cash and you put enough expensive piece of film equipment. So let's think about that, cause I'm actually doing that later. In the QuickBooks section, cash increases on asset is created called equipment. But the question is, what's the other side of that? Well, the other side of that is that you is the person who put in the cash and the film equipment now have that dollar amount of equity or ownership. So if you put in $10,000 in cash and a $10,000 piece of equipment, you the only now have $20,000 in equity, which again relates back to the claim on assets. Okay, your claim on assets as a zone owner. Is that $20,000 you're seeing is an owner? I put that money in, and I put that equipment that makes sense. Okay. Are you, ah, classifying loaning me your company money and investing as the same thing? Because a lot of times I will classify it is investing in the company. Whereas loaning, uh, you might not get such a in the future. It's an important point. For the most part, I recommend that you that you account for money or other things that you put in the business other assets as an equity investment and not as alone, because usually your intention is toe leave that money in there anyway, long term. Now there are exceptions. If you write a check and then you get the money back in 30 days because you've got to make payroll or something. I get that. But generally, since you're gonna leave it in their long term, I would classify it as an asset going back to the balance sheet statement and not a liability. Okay, what's on the screen next is finally again what I mentioned earlier, the matching principle, which is that the revenue create should be matched with the expenses you incur to create that revenue. Now, let me let me get emphasize. This is a way of calculating profitability. It is not necessarily something that's going to get posted and be clear in the balance sheet of the income statement. Okay, this is your own internal calculation of Am I making any money? Okay. I want to make that clear. The matching principle is not necessarily a balance sheet or an income statement or something that is clear in either one. Okay, we now introduce a new term called the A Cruel Method Again. Accounting jargon trying to minimize it, but an important one for you guys to know. Let me define it. First matches revenue with sales, regardless of when the cash moves, regardless of when the cash moves that allows for matching. Let me say it a different way. The cash method of accounting, which is not on the screen, is accounting for your revenue and expenses purely by your checkbook. Does that sound like an accurate way to do this? I hope not. Okay, that's not an accurate way. Hey, I got some cash on the door which reminds me of my son, Connor, shout out to Connor, Connor, being a creative has difficulty rate embarrassing. Has difficulty tracking money. Let me give you an example. He gets a certain amount. He made money over the summer. Good job. His mother, who handles everything, gradually doles the money out to him. The question came up during the summer is a freshman summer before he left? How often should we dole out the money to Connor? We decided he included about once a month. So on January 1st, bear in mind. He's not even gone yet. He's still living at home, eating our food. Burn up my gas money. He's not even gone yet, and we give him the money that he's supposed to use from January 15th of January 31st. What happens on January 5th? It's completely gone. It's completely gone, because all I see is he's getting in my car and you have to realize that he's 65 He's a big guy and he's driving my car too fast food, and he has just running through cash like you can't believe so on a cash basis. He's losing his shirt because it's all expenses, so we don't want to do our accounting on the cash pissed. In fact, if you're serious and I know all of you are about being in business, don't use the cash myth use instead. This term, the accrual method and I have on the slide. Nearly all businesses of any size used the accrual method. Now, red flag just heads up. Tax returns may use the cash method. They're upset. Tax returns, menus, cash method. That's not the point of this course. Okay, so don't be confused. If your accountant in April goes hand your financials and they may see cash myth in on it. Okay? That's a whole different ballgame. That's not for the scores. For this course, we used the A cruel method of accounting. Okay, why? And yellow the bug. The only way to truly match a sale in one period with the expensive and another. Okay. Now, practically How many of you know somebody who works in a seasonal business? You might know somebody works this season. Yes. What business is it worth? Sesay permitting Photography, wedding photography, wedding photography. Yeah. We suspect that the guy who did our wedding photography was in jail at some point I don't know how that came up, but as my daughter would say, sketching he was kind of a sketchy guy. That was a long time ago. This thing was Kim and I still see his face. And it was it was unclear how professional Kim was, but he ended up taking our pictures, so that's a seasonal business, right? Um, retail, another seasonal business. Most of those people in retail are not making their maker break is from third week of November through December 31st. And that's make or break. Okay, So you can imagine in the reason that I bring this up that this this cash meth, this cash activity can be very different from your revenue and expenses. Because if you got a Hallmark shop and you're doing all your revenue, the vast majority over between November 15 and December 31st do you think you have a lot of cash in the door in January 1st? Probably. So. So your cash rich. Okay. But you gotta bear in mind that you've got all those expenses from early January to November again to manage. Okay, So the problem in those six sexual businesses, those seasonal businesses You got to really be careful managing money, swimming pool, business. Guy lives around the corner from me. He has a business called Liquid Assets and he build swimming pools. Kind of. He's got a great logo side of his truck. It's his liquid assets, and it has like drops of water. That's a seasonal business. They're building a house down the street from me. The reason I know is is that at 6 45 in the morning last Saturday morning, they were running equipment. They're always doing the same thing Sunday morning. I don't normally get up at 6 45 on Sunday morning or Saturday morning, but I did those two days because they were running equipment. Trades is another good example, outdoor. I was talking to some bricklayers at the house, and I said, How cold can it be before you can't lay break anymore? He said. 28 degrees. And if it gets below 28 degrees, we can't do it. If it's below 30 degrees, they have to use blow torches to keep the PSAT the mortar soft enough to be able to stick to the bricks. That's a seasonal business. Okay, many people who are in the trades. Roofers, for example. Those guys just shut down in my area from November, December January. They're shutting down. They're not doing any business. You can't put a roof on a house generally when it's, you know, degrees. Okay, This means that people who are profitable using the matching principle are in big trouble. If they don't manage their cash correctly, see what I mean? There's a little confusion. Granata asked him. Are used that are you? When we were talking about matching principle and cash method for taxes, you made a statement. I think that she understood it to say that we would need to keep two sets of Oh, okay. Is that the case, or is that I'm glad that was asked. No, I am not suggesting you to keep two sets of books. All I am saying is, is that when you give your information to an accountant, there are cases particularly in your business. Gets bigger that it may. There may be parts of this that are accounted for in the cash basis. I just don't want somebody to watch the course and leave and get a tax return done, and wonder. Wait a minute. I heard on the course never to use the cash. Myth wise. Yeah, that's what I mean. Great. Thank you. One set of financials using the accrual now. All right, this is my favorite graphic. I think again, I'm gonna count. I don't do graphics very well, but this is cool. So July 2000 and off attire for travels to New Zealand to take photos. He might not even have a buyer yet. How many of you done created? Look where you don't even have a buyer. You sure? Right. Uh, December 2013. You sell the New Zealand photos in December of that year. Okay, This is the example similar to what I used earlier. What's the calculation on profit? Well, it's the December revenue. Less than July expenses equals your profit I put down in the right hand corner. The whole reason you spent the money in July is so you could profit and sell the pictures sometime later. Okay? Otherwise you wouldn't have incurred the expense in July. You wouldn't have incurred the expense in July. Okay? Matching principle. A couple other examples. Um, I'm glancing at my screen here is that again? I'm gonna say it again. The whole disconnection from cash, income statement, balance sheet or disconnected from your cash activity. It's so important. And it's worth saying multiple times Question, Yes. Do you recommend carrying that over multiple years or just keeping it in one year? Good question. Bear with me. Just a minute. I'm trying to get back to There we go. Let me just go to the next slide. No answer that. Okay? This can happen over multiple years. So the question is, do you recommend, you know, how does the changing from one year in another plan to it? You just keep moving forward. Here's what I mean, if you have payroll expense on December 30 on December 31st you've got payroll that you over the last week of December. That's an expense in 2014 even though you imperia. Then in January 5th, you run payroll 2015 and you actually pay the cash. That's an expense. In the prior year, we'll talk about how you do that later, so it goes over for months, a month, but it also goes over from year to year. In other words, you can have situations where the income in the or the expenses in one year and the cash moves in another year. Is that my answering it? Okay, so the cash metal accounting again is your checkbook, where your deposited revenue or sales I'm using the terms interchangeably, and the checks are your expenses or debits coming out of your account. I've covered this slide other than to say that the cash method again distorts your profit calculations. Okay said another way, because it's so important at the bottom of the page. The accrual method and profit does not match your inflows and outflows. I beating it to death. But it's so important because people who are novices to accounting don't get it. They just don't quite get that. So I'm really trying to beat it to death. Okay, finally, double entry accounting. And again, this is I'm We've got some accounting jargon. It's not your thing for most creative people, but we're giving you just enough to know to run your business. And specifically, I have to cover this before I go into QuickBooks. Double entry accounting means defined at the top each entry into the records, the accounting records has two sides. You have a debit, at least one. And you have a credit, at least one. In other words, you cannot have a transaction without at least a credit or without at least one debit. Okay, When I tutor people in accounting, I use what's called a T account, which I say here. And I know that position is kind of bad visually explains the process. And the reason I'm standing here is is that I've got a line here. But if you can imagine a vertical line between debit amounting credit amount A T OK, a t. This reminds my classes ST Louis, you where I said you gotta You gotta memorized page 89. Can you explain to me memorize Page 89 Don't care until you memorize page 89. You can't ask me any questions about this. What are the rules? Debit is always on the left now. Well, let me say credit, and then I'll do right now. Credit is always on the right. Always. This is confusing when you think about your banking, right? Ah, credit is a cash inflow in a debit. Is a debit out of your debit out of your account, right? Ignore terminology you use for your personal banking for right now. Let's set that aside. Debits are always in the left. Credits are always in the right and at the bottom, total debits will always equal total credits. So if you run through 30 transactions Democratic, democratic, democratic, different amounts they have toe all add up to the same dollar amount toll or a system like QuickBooks will give you an error message. Okay, These are always true. However, depending on the type of transaction, how you which which you do debit or credit can be different. You follow me. I want to make that point. Example. Transaction. For those of you who were wondering, I just can't wait for him to get into the accounting transactions. So awesome. We're finally here. We're finally here. You know, that's a joke. You by $500 of photography equipment. Now, that is an asset that you're going to use to work in your business, right? For six months years. It would not make sense as a result to immediately expense it. Why? Because it isn't asset that you're going to use for months or years. Okay, so let's agree at the beginning that the photography equipment is an asset. All right, if we agree, the equipment will be used over two or three years, we debit on account, call debit photography equipment, which is an asset debit increases in asset account credit cash, which is an asset to decrease cash to decrease cash. Okay, so if you can imagine a T account, what we did for this transaction is the left hand side of the T account. Increased by $500 for equipment. The right hand side of the T account, the credit posted $500 for the decline in cash. Okay, when we get to QuickBooks, that springs up a good point. When you see me start this this afternoon. What you will see that I did to post some transactions was I did something called a journal entry. Just like writing in a journal. My youngest got a journal for her birthday from my from her brother. Her brother was her secret Santa, and he went to the mall and he got her a leather bound, uh, journal. And we just thought that was so nice because usually they fight like cats and dogs and isn't that nice that her brother did was very thoughtful, chief, and gave him a hug before he left for college again, Thank you from a journal. So a journal entry is essentially where you're putting all the transactions that look like that. What I mean by that, as you're gonna write down debit or credit the account two accounts in this case, photography equipment in cash and the amount and you're going to have line after line after line. How does that connect to QuickBooks? My suggestion to you is that you meant until you get used to using QuickBooks that you and you will see how I did it, that you manually post these entries rather than letting go into a QuickBooks window where it's done for you. Where is it done for you? For example, When you create an invoice, QuickBooks post the journal automatically for you. The problem is, when you don't have a lot of experience at it, you create an invoice for somebody and you look at your balance. Hearing of statement. Go. Where did that come from? I don't know What. So my suggestion is that you do it manually at the start just to get used to it. Conversation in the chat rooms about debit and credit and getting used to the terms. And Scott Scott Hamel actually said debit credit was definitely the biggest mental hurdle when learning accounting. And a few other people have said something similar was just wondering for you if you have any tips or tricks to kind of get over that little bit of a hurdle. Ah, couple, there's two big ones. The first is debits on the left. Prints are on the right. Those are the two fixed rules, all of the other rules about how you post transactions can be different. And in fact, I'm going to cover that in a in the QuickBooks later today and in the later segment. Here's what I mean. Let me give you a little preview. Asset accounts always get increased by debuting asset accounts get increased by deboning. However, liability and equity accounts get increased by crediting Oh my gosh, there's two methods. Yes, there's too much. Okay, So even though Deb it's on the left and credits are on the right, how you increase an account or decrease it depends on the kind of account it is. This is This is the hurdle. But debits are always on the left and credits arrives on the right. That's doesn't change. Now let me go back some slides and expand. Tell you why it might make logical sense. The debits are on his left. Incorrect served in the war. So you see that formula there Now? I said that assets are increased by deboning, so all the asset increases air debited on the left, liabilities and equity are increased by crediting. So what you end up with is ah, big pile of debits for assets and a big pile of credits for your liability in equity accounts. See what I mean? It evens out both sides of equal sign. Let me do that again. Assets are increased by deboning big pile of debits, liabilities and equity or increase by crediting big pile of credits. And the two piles have to equal each other. Okay, One other thing. If you're learning accounting maybe beyond, I'm not gonna say be on the scope of this class, one of the point I want to make before we get too far gone here because I mentioned that what I had on the screen for that equipment transaction in Cash was a journal entry, and after doing it, the the Inefficient Way. For years I finally figured out how to teach it a lot better way. And here's what I mean, What I have on the screen is a journal entry a lot easier. Way to understand what's going on there is to put it in a T account. So when I teach accounting and I teach these transactions, I put him in a T account because then you can visually see left and right better. I don't teach it in terms of a journal entry like it is there. So if you're thinking about your accounting and you're putting something in the QuickBooks and you're confused about debit and credit, left and right, do a little T account. In this example, you would have elite little T account that says photography at the top. You would debit it on the left for 500. You have another key account that has cash at the top. You credited for 500. I got a left and right visually easier took me years to figure out that's the way to teach it to people to you. Count, this is a question, and I'll let our hosts pick up here in just a second. But one thing I'd like to sort of set the groundwork for is And you really did a great job the audience did of teeing this up. And also people in the chat room. Um, for the next segment, which is what is your impression of QuickBooks? Okay, we had a discussion in the hall about, um there's 50. Does anybody remember Baskin Robbins? Am I so nice? So is it still around? How about orange Julius, Remember once, Julius? Yeah, because this is how you know, by the time I'm doing this and I'm 70 people are gonna go. None of his analogies makes what What are you talking about that doesn't even exist anymore? Was one of the things I usually say is there's 51 flavors, right? Baskin Robbins was 51. That's my point. There is a point. There's 51 flavors of QuickBooks because there's different versions and add ons. It's a little more complicated than what meets the eye. Do you see what I'm saying? So one of the things we found out When you guys were asking me questions in the beginning. Waas did you payroll to do inventory to do fixed assets, did you to do all those things you may have to get on and on for QuickBooks. So going into the next segment, think about your impression. QuickBooks, are you intimidated by it? Have you started to use it? And, um, it's going okay. Have you posted some transactions somewhere And they've disappeared into the, you know, the the black hole. The death star, somewhere of QuickBooks. You don't know where they are. Are you putting off? Are you d have reports coming up and you don't even know what the reports are? All this is very common. Very common. It's not your bag. It's not primarily what you do. This is just a means to an end. So that's what I would suggest is to think about for both the audience online in the Internet and for you. What's your impression of quickly? Great. All right, we have any questions here in the studio. Templates there already set up that your business can fit into our great question. Yes, they do. So they have something called and I needed to mention it here. A chart of accounts. So every business has a chart of accounts. These air the accounts you're going to use your do your accounting. So if you're a retail, you'll have inventory and you'll have cost of sales because that's unique to having inventory. So, yes, the answer is depending on your industry. When you fill out the QuickBooks set up not necessarily online. But the more advanced versions it will ask you, What industry are you in? And you say construction and they show you a chart of accounts. And they say, Do you want to use all these? And by the way, you can change him. You can delete her ad. But yes, it is specialized question here from David in Puerto Rico. And he wants to know, are all equipment purchases entered as assets, regardless of cost? Good question. Another way of saying that question is, when do I create an asset as an expense as it? How do I create an asset for equipment and when do I just expensive? If you're gonna if you're going Teoh. If the let me say this way, if the asset has used for any reasonable length of time. You're probably going to create an asset office supplies. For example. Most people just automatically expense for all the supplies. I don't know what I'm gonna use the pencil or the erasure of the stapler anymore, so we just expensive. Did you know immediately, however, butts and ask that you think you're gonna get something out of for a month or two or longer create an asset?