When consumers purchase a product, many things happen behind the scenes before that box hits their front porch. Manufacturers need to order materials and components for producing the product, receive them, house them in a warehouse, and assemble and distribute the final product. 

During this process, there is a lot of data to keep track of, such as lot numbers, serial numbers, costs, quantities, expiration dates, etc. This data needs to be tracked and continually updated after every step to ensure efficient production. 

Inventory management is the process of tracking and managing inventory from the time it is acquired to the time it is sold. Inventory includes raw materials, work in progress, and finished products.

Establishing an accounting system for inventory is essential to maximizing profit. In this article, we will discuss the entire inventory management process, from tracking raw materials and the benefits of implementing an inventory system. Additionally, we will walk you through selecting a system that works for you and your organization. 

 

Benefits to Managing Inventory

There are many benefits to managing inventory and putting a system in place that is consistently updated when changes are made. Inventory management systems can help businesses track their inventory levels and prevent stockouts.

Inventory systems can also help businesses save money by reducing the number of raw materials and finished products that need to be stored while still ensuring enough product is on hand to meet demand.

Creating a consistent process will help businesses maximize their income by ensuring that finished products are sold quickly while preventing a surplus of stock from being moved.

 

Initial Steps

The first step in inventory management is acquiring and tracking raw materials. Raw materials can be purchased from suppliers or extracted from the environment. Once raw materials are received, they must be stored until required for production. Inventory systems track all raw materials’ quantity, location, and condition.

After receiving materials, they need to be stored in a warehouse or facility until it is time to assemble the final products. 

During production, the process from storage to the assembly line is called work in process. Production can be done in-house or outsourced to manufacturers. In either case, inventory management systems track the progress of production and the finished products as they are completed. Integrating tools like visual CPQ (Configure, Price, Quote) can enhance inventory management by enabling detailed customization options during the production phase, ensuring that specific customer requirements are considered efficiently. Visual CPQ can streamline product configuration and provide a visual representation of the final product, reducing errors and ensuring accuracy in tracking work in process.

Once production is complete, the finished products must be stored until sold. It is essential to track all final products’ quantity, location, and condition. When customers purchase products, the system is updated to reflect the decrease in inventory after distribution.

 

Selecting a System

If you are interested in implementing an inventory management system in your business, keep a few things in mind. The central place to start is determining what type of system you want to use. 

Inventory management systems can be either manual or automated. Manual methods are typically less expensive to implement, but they require more time and effort to maintain. Automated systems are the opposite, more expensive to implement, but they can save you time and money in the long run.

Additionally, it would be best to establish how often to update your inventory levels. Inventory levels can be updated daily, weekly, monthly, or quarterly. Updating stock levels more frequently will require more time and effort, but it can help you track your inventory better.

 

Inventory Accounting

Once you have decided on a system, you need to track three things:

1. Inventory Quantity – can be tracked through your method of choice, either manually or automated.

2. Cost of Inventory – includes the purchase price, transportation costs, and storage costs.

3. Value of Inventory – the inventory’s selling price minus the cost.

Choosing the right inventory valuation method is a crucial step as it can significantly impact your reported profitability. There are two main inventory valuation methods, LIFO (Last-In-First Out) and FIFO (First-In-First Out). These terms originate from when goods were moved around on shelves in stores. The method determines the price point of the product. An item can be sold at a higher price due to increased demand or at a lower price due to expiration, storage costs, etc. 

Here is a simple example to illustrate the difference between FIFO and LIFO. Let’s say a toy company buys and sells drones for kids. This company has purchased four drones per month in January, February, March, and April. However, due to inflation, the cost of the toy for the company got more expensive. There is a consistent cost increase for each successive month. Refer to the table below.

 

The toy company just got a shipment request for 12 drones. Refer to the table below to see the difference in COGS for the FIFO method compared to LIFO. 

 

Using this example, the toy company would probably institute the LIFO method as this number reflects a higher inventory cost, meaning less profit and fewer taxes to pay at the end of the period.

Conclusion

Overall, inventory accounting aims to keep track of the cost of goods sold (COGS), which includes the cost of acquiring, storing, and selling inventory. COGS is a crucial metric for businesses because it directly impacts profitability. As a result, companies must carefully track their inventory levels and monitor their COGS to ensure they are maximizing profits.

Inventory management is an essential part of any business. Businesses must have an accurate picture of their inventory levels and costs to make informed decisions about purchasing, pricing, and selling products. This system is critical for any business that sells physical products; accounting for them consistently can be the difference between success and failure. 

 

Learn more about accounting with FINSYNC’s cloud-based accounting platform to help you better manage your business operations.

 

Whether your company is merchandising, manufacturing, or service-based, keeping track of your production costs is vital. To optimize your total output and expenditures, you need to understand and track marginal cost and revenue. 

Whenever a company increases its production, there is always an increase in production costs that must be recognized. Marginal and variable costs consider these increases and determine the optimal amount of units or labor required to keep production costs as efficient as possible. 

We have already covered the importance of tracking variable costs within your organization. Now we will discuss the importance of marginal cost and marginal revenue and why they are critical concepts in managerial accounting. 

Importance of Marginal Cost

Marginal cost refers to the additional cost to produce each additional unit. In other words, this cost shows the increase or decrease in the cost of making one more item in production. The formula for calculating marginal cost is below:

For example, if the cost for a company to produce 10 units of a product or service is $5,000, and the cost to build 11 units is $5,010. In this case, the marginal cost for that additional unit is $10.

Marginal cost plays a crucial role in an organization, especially when a company must decrease its costs. Fixed costs are constant regardless of production levels; higher production leads to a lower fixed cost per unit as the total expenses are allocated across more units. 

The marginal cost of production includes all expenses not fixed. For example, if a company needs to buy a new piece of equipment to produce more units, this is a marginal cost. The marginal cost varies according to the volume of the products constructed.

Marginal Revenue

Marginal revenue (MR) is essentially the opposite of marginal cost. MR is the increase in revenue that results from the sale of one additional unit of product and is calculated by dividing the change in the total revenue by the difference in the quantity.

While marginal revenue can remain constant over a certain level of production output, it follows the law of diminishing returns, which states that any production increase will result in smaller increases in output. It means the company has surpassed its optimal level.

Example: A lava lamp business brings in $30 in revenue by producing its first lamp. Initially, its marginal revenue will be $30. If the same company makes a second unit and brings in another $25 in revenue for a total of $55, then the marginal revenue gained from that additional unit is $25. 

Over time as the demand for lava lamps increases, output increases, and eventually, there will be a point when the business incurs more significant variable costs. For example, if the company is now producing 1,000 lava lamps per day, they eventually need to hire extra staff to package or run quality control checks. Thus the marginal revenue decreases to $23, then $22. The curve begins to slope upward when operations become less efficient and profitability decreases.

Working Together

Both marginal cost and marginal revenue work in tandem to help businesses set their output target in production. These two metrics are adjusted as production costs fluctuate. The ultimate goal is maximum profitability when marginal cost and marginal revenue are equal. 

If marginal revenue were greater than marginal cost, then that would mean the company can continue making more units until the marginal cost is higher than marginal revenue. As we discussed previously, this diminishing returns point is where the company is losing money in producing more units and should scale back on output or increase the sales price. 

Although having a high marginal revenue over a long period is not always a good thing, this discrepancy shows that the company is continually not meeting its customer demand. 

On the other hand, when marginal revenue falls below the expected value, it is important to conduct a market analysis to determine the reason. Possibly there are too many competitors saturating the market, or the market trend for the product has peaked. Either way, the cause must be revealed in order to prepare for the next steps.

Conclusion

Every organization must focus on increasing revenue and net income to improve profitability. Therefore, businesses need to concentrate on how each sale affects the bottom line to produce stable sales revenue flows. To do this, you must track marginal revenue and marginal cost.

Ultimately, analyzing these two numbers and how they impact each other is critical to maximizing your profit, optimizing your team’s performance, and overall your company’s productivity.

 

Now that you are familiar with marginal cost and marginal revenue, it is time to put this into action. Signup for a FINSYNC free trial to experience financial harmony with your business. 

We are all part of a societal landscape that tracks everything. How many steps we take, how many calories we eat, and how many miles we have driven. If only there was a space to transfer and analyze all of this data in one place. In the accounting world, this place is called the general ledger.

We recently explained how to document your business transactions via journal entries. The most common method of presentation of that “journal” is the General Ledger, where all of these transactions are housed. 

The General Ledger or GL is the backbone of any accounting system. The GL breaks out all of the transactions by category and then within each category, transactions are listed chronologically. This article covers the purpose of a general ledger, identifying each of the five different sections and how they operate within a double-entry bookkeeping system. 

Purpose of a General Ledger

A General Ledger aims to help track and evaluate every financial transaction for your small business. This information is the foundation of the organization’s financial statements. 

You can equate a GL to a computer database. All the code/systems run off the information within this database. Performing individual tasks will reanalyze and ultimately update the systems within the database.

By comparing transaction data from one period to the next, you can identify trends, unusual behavior, or areas of concern. In addition, the GL is helpful when filing taxes since all income and expense transactions are categorized in one location.

Ledger Accounts

The five sections of a General Ledger break out individual transactions mirrored in the Balance Sheet and Income Statement. 

1. 1. Assets (Balance Sheet) – Assets represent what a business owns and produce value. Examples of assets include cash, land, buildings, and equipment. 
   2. Liabilities (Balance Sheet) – GL liability accounts represent the financial obligations that a business entity owes to outside parties. Examples include amounts due to suppliers or bank loans.
   3. Equity (Balance Sheet) – Equity is the difference between total assets and total liabilities. If a business was to sell its assets to pay all its liabilities, the cash remaining is known as equity or what is left over for owners. The equity balance consists of retained earnings, common stock, and additional paid-in capital.
   4. Revenue (Income Statement) – Revenue is the business’s income derived from the sales of its products or services. Revenue or income is measured from one period to the next and provides economic benefits to the company.
   5. Expenses (Income Statement) – Expenses consist of the money paid by the business in exchange for a product or service. Expenses can include rent, utilities, travel, and meals.

Double-Entry Bookkeeping

A fundamental principle in accounting is the “Accounting Equation”: Assets = Liabilities + Shareholders’ Equity. These numbers are documented via the balance sheet. The double-entry accounting system ensures that this principle equation always stays in balance. 

A debit is an accounting entry that increases an asset or expense and decreases a liability or equity account, and a credit does the opposite. If your debits and credits do not balance, you know a mistake was made and must be identified.

Therefore, for debits and credits to balance, an entry on the debit side must be accompanied by a corresponding entry on the credit side and vice versa. 

For example, when a bookkeeper enters a credit entry into the general ledger, this increases the equity and positively impacts the liabilities account. At the same time, the debit account will decrease because there is now more cash in the bank.

Implementing a double-entry system is like utilizing a system with built-in checks and balances. 

Bottom line

Financial reports consist of a balance sheet, profit and loss account, and statement of cash flows; however, this data doesn’t tell the whole story because these statements are all summary data (transactions are summed during the period).

On the other hand, you can see every individual transaction within a general ledger. Sometimes, it is necessary to dig into dozens of journal entries to identify the core issue. Thus, all of this data must exist in one place. 

Overall, general ledgers are master records that house the financial transactions of your business. Once you understand and start using a general ledger, you will soon realize how powerful and vital it is within your small business. 

 

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Is your business spending too much money on materials? Can you afford to hire a new engineer? Good financial statements will help you answer those questions and more. Journal entries are the fundamental building blocks that financial statements summarize to help you understand your company’s profitability and other financial metrics.

Learning how to create a journal entry is one of the essential steps to ensuring a company’s accurate financial record keeping. In addition, these transaction entries keep tight controls around the most important financial metric, an organization’s cash flow. 

Since the 15th century, many companies have employed the accrual accounting system to track their debits and credits. Even though numerous businesses continue to follow a cash basis system, it is crucial to understand journal entries within the double-entry system for both types of accounting.

What Is a Journal Entry

A journal entry (JE) is a way to record or correct a financial transaction in a company’s accounting system. These transactions are recorded in the company’s book/journal, called the general ledger.

JE’s consist of header and row information, are the first step of the accounting cycle, and record the detailed transaction on a specific purchase, for example. 

For taxes and other external stakeholder requirements, businesses use double-entry accounting. This bookkeeping system involves debits and credits, and each side must match or “balance” exactly. There’s a specific report to check for “out of balance” transactions called the trial balance.

Maintaining consistent records of your transactions helps keep your company information organized. Recording this data chronologically makes it easy to locate important information, identify potential accounting errors, and simplify your cash flow management. 

Since journal entries are the first step in the recording process, it is a precursor to creating financial statements such as the income statement, balance sheet, and statement of cash flows. 

In addition, auditors use the information contained in the journal entries to monitor company performance and profitability.

Debits and Credits

Money doesn’t just disappear or appear out of nowhere. It has to come from somewhere, and go somewhere. Here is where debits and credits become valuable. 

Debits and credits are bookkeeping entries that balance each other out. These two terms signify actual accounting functions, both of which cause increases and decreases in accounts, depending on the type of account.

An example of a debit and credit is purchasing a piece of equipment such as a laptop for your company.  Economically, one asset (cash) has been traded for another (equipment). In this scenario, we would credit cash to reduce it and debit equipment to increase it by the value of the laptop.

Recording Journal Entries

To record a journal entry, begin by entering the date of the transaction in the journal’s date column. In the rows, list each account affected by the transaction on a separate line.

Identify if the transaction is a debit or credit. You can use this acronym for guidance: DEA-LER

DEA represents the debits that go on the left side: dividends, expenses, assets, and LER represents the credits on the right: liabilities, equity, revenue. 

An example of a journal entry within the service industry would be payroll. If you pay someone $5,000 this period, this transaction is considered a business expense under the debit entry, and the credit entry must equal the $5,000 under cash or liability. 

Automation to the Rescue

An automated journal entry system saves you time and reduces the amount of duplicate work accountants, and bookkeepers often need to endure. As accounting systems grow in complexity and the number of journal entries increases exponentially, at some point, it only makes sense to employ an automated accounting software system.  

Transactions like the examples provided in this article are automatically entered into the correct account when paying a bill or invoicing a client. Invoices are credited, payments are processed, and bills are paid automatically according to your dictated parameters. 

Even with automation software, accountants still need to make a few manual journal entries, such as adjusting accruals, depreciation, and amortization sometimes referred to as “non-cash” entries.

 

Try FINSYNC’s accounting software with no upfront cost. The all-in-one platform allows you to create, review and approve journal entries while simplifying your cash flow management.

You just purchased a new asset for your business; wouldn’t it be wonderful if you never had to worry about it again? That piece of equipment or machinery never needed maintenance and never needed replacing ever again. 

 

Unfortunately, this isn’t the reality, and organizations need to track accumulated depreciation to ensure operations continue to run smoothly.

 

Accumulated depreciation is not to be confused with regular depreciation. However, the only difference lies in the fact that depreciation appears as an expense on the income statement, and accumulated depreciation is reported on the balance sheet.

 

This article defines what accumulated depreciation is, how it is calculated and recorded, and the importance of keeping track of this vital piece of accounting.

 

Definition

 

Accumulated depreciation is the total depreciation of a fixed asset since it was placed in service. For every asset a business has in use, there are two numbers associated: the cost basis and accumulated depreciation.  

 

Cost basis or historical cost is how much the equipment or machinery originally cost. This number is documented and verified via the purchase receipt. Accumulated depreciation is how much value this asset has lost and now reduces the value of the asset on your balance sheet. This special type of account that impacts assets by reducing their value is called a “contra-asset” account.

 

The purpose of tracking the accumulated depreciation is to spread the total cost of an asset over its useful life or for as long as the asset is used by the business. Since each asset loses value each year and that loss is treated as an expense, depreciation also affects net income. 

 

Two Calculation Methods

 

Depreciation can be calculated on a monthly basis in two different ways. Either straight-line method or declining balance method is recognized by the IRS. A business needs to calculate the depreciation of every asset each month over the course of three to twenty years. 

 

Straight Line Method – This method depreciates your property at an equal amount each year over the product lifespan. Straight line depreciation is used when there’s no pattern to how the asset is used over time. This method is the most straightforward method of calculating depreciation. 

 

 

Declining Method – The declining depreciation method is a system of recording larger expenses during the earlier years of an asset’s life and then smaller amounts during its later years. This method is based on the assumption that the piece of equipment such as a laptop will depreciate more quickly in the first few years versus at year 10. 

 

 

There are two commonly used forms of the declining balance method: the 150% declining method, and the double-declining method. 

 

◦ The depreciation factor under the 150% declining method is 150% or 1.5.

◦ Under the double-declining method, the depreciation factor is 200% or 2.

 

 

Examples

 

A small board game company called RealBlox needs to purchase an asset such as a cardboard printer to create board games on a commercial scale. This asset will cost $120,000 and is expected to last for 10 years, then, at the end of its life lifecycle, it will sell for around $2,000.

 

Using straight line depreciation, our formula will look like this:

 

 

RealBlox will need to recognize a yearly depreciation expense of $11,800.

 

Shane is setting up his own power washing business and needs to buy equipment totaling $50,000. He expects the assets to last 4 years but doesn’t expect any salvage value after this point. 

 

If we use the 150% declining depreciation method our formula will look like this: 

 

 

After the first year, Shane will need to recognize a depreciation expense of $18,750 or $1,562.50 per month if the accounting periods are monthly.

 

For year two, Shane will need to subtract the $18,750 from the historical price of $50,000. Therefore, his beginning book value for Year 2 will be $31,250, and repeat the equation for each year. 

 

Importance of Accumulated Depreciation

 

Businesses track accumulated depreciation for each asset on the balance sheet. Each period, the depreciation expense increases accumulated depreciation and reduces the value of the asset over its lifecycle. 

 

When a company sees a number of critical assets on its balance sheet with high accumulated depreciation, that’s a good indicator that replacement may be required soon.

 

For outside companies considering the purchase of a company with many pieces of critical equipment, a list that includes assets along with their accumulated depreciation is necessary to avoid surprises due to failing equipment or overpaying, thinking assets have many years of functional life left.

 

How FINSYNC Can Help

 

FINSYNC allows you to run your business on One Platform. You can send and receive payments, process payroll, automate accounting, and manage cash flow. To learn more about how we can help your business start, scale, and succeed, contact us today.

 

 

The statement of cash flows, or the cash flow statement, is one of the three primary financial statements used to determine a company’s financial health. The other two statements, the balance sheet and income statement, have already been addressed in previous articles. 

 

This article centers on the statement of cash flows under the accrual accounting method, where transactions are recorded in the general ledger as soon as they are earned or incurred. This recording happens even if the cash has not yet changed hands. 

 

This process of regulating the cash coming in and going out over a period of time is vital to the success of a business. We will cover the importance of developing a cash flow statement, the components, and how to calculate and interpret this valuable data. 

 

Why Do We Need a Cash Flow Statement?

 

The cash flow statement (CFS) takes the previous period’s ending cash or net income. It compares this to the closing amount of the current period while tracking the precise cash movement throughout the entire period.

 

An important factor from a business perspective is the CFS can verify that the revenues and expenses reported on the income statement are consistent with the actual cash movement in and out of the organization. Because of this, the CFS acts as a bridge between the income statement and the balance sheet. 

 

Another important factor in creating a cash flow statement is liquidity. Regardless of your company’s revenue, you must ensure enough liquid cash to cover necessary expenses like taxes and payroll. 

 

Finally, one can use the cash flow statement to create cash flow projections. These projections allow you to plan for the future and understand how much money your business has 6-12 months down the road. If you are secure in your cash flow projections a year from now, you can be more confident in making purchases now. 

 

Components of a Statement of Cash Flows

 

There are three main sections within the statement of cash flows. Each examines a different source and uses for the cash. These are operating activities, investing activities, and financing activities. Together, all three comprise the basic structure of the cash flow statement and are detailed below.

 

1. Operating activities – are the main revenue-generating activities of the business. These transactions monitor when a company has delivered its goods or services. 

2. Investing activities – are set outside of the business’s core activities. This group includes selling or purchasing property, stock in other companies, patents, etc.

3. Financing activities – are related to funding the business. This cash involves repayment or equity to third-party banks or business owners. 

 

Both revenue and expenses are in each of these groups. Negative numbers represent cash outflows, and positive numbers represent inflows. Generally, a company is successful if it consistently brings in more cash than it spends.

 

Calculation Methods

 

To calculate your organization’s cash flow, you need to apply either the direct or indirect method. 

 

◦ Direct method: this method mirrors the income statement. Under operating activities, the cash receipts from customers reflect revenue and cash paid to suppliers, employees, loan interest, and taxes mirror expenses. The company needs to produce and track cash receipts for every cash transaction. For that reason, smaller businesses typically prefer the indirect method.

◦ Indirect method: The indirect cash flow method is more straightforward, as it doesn’t require details of every cash movement, such as the date and amount of cash received and when a customer pays for goods. All the figures needed are on the income statement and the balance sheet.

 

A benefit of the direct method is that it is more precise. This precision makes the direct method an advantage if a business is experiencing cash flow problems and must calculate these metrics regularly. However, the indirect method is the more practical choice most of the time.

 

Final Thoughts

 

Cash flow statements reveal to investors and lenders which phase the business is currently operating. Analyzing the numbers indicates if a company is a rapidly growing startup or a mature and profitable company. It can also reveal whether a company is going through a transition or in a state of decline.

 

The CFS shows a different aspect of your business that the other two financial statements overlook. You can see how much cash a specific product or service generates or if a business is spending too much on its investments. This information allows owners and managers to make appropriate changes to the organization as necessary.

 

A company’s understanding of its cash inflows and outflows is critical for meeting its short-term and long-term obligations to its vendors and suppliers, employees, and lenders. In addition, seeing how your cash changes over time, rather than an absolute dollar amount at a specific point in time, is a solid metric to recognize for your company’s financial well-being.

 

How FINSYNC Can Help

 

FINSYNC allows you to run your business on One Platform. You can send and receive payments, process payroll, automate accounting, and manage cash flow. To learn more about how we can help your business start, scale, and succeed, contact us today.

 

Out of the three primary financial statements, we have already covered the balance sheet, which represents the value of your business at a specific point in time. This article focuses on the income statement, which outlines the profitability of your organization over a period of time.  

As a business owner, it is critical to read and analyze data from the income statement. Not only can you determine your company’s current financial health, but this understanding can also help you predict future opportunities, optimize business strategy, and create meaningful goals for your team.

Understanding the Income Statement

The income statement or profit and loss (P&L) illustrates how much income your business makes or loses during a period. The result is either a profit or a loss by subtracting expenses, possibly including cost of goods sold (COGS), from the total revenue.

The core function of the income statement is to disclose the company’s net income by comparing these profits and losses.

Business owners can refer to this statement to reveal if the business is spending more than they earn and the effectiveness of new strategies. Based on their analysis, owners can determine if they will generate more profit by increasing revenue or decreasing costs. 

Income Statement Format

An income statement should include all of the following line items:

1. 1. Total revenue: Revenue or operating income is your company’s income from its normal business operations.
   2. Cost of goods sold (optiona: COGS is the direct cost your company pays to make the product it sells, including the raw material and labor costs. Service companies don’t typically include this section.
   3. Gross profit: Gross profit is the net sales minus the total cost of goods sold. This metric shows how much a company would have made had it not incurred other expenses. 
   4. Gains: Gain results from selling appreciated assets that cause an increase in an organization’s income. This number differs from regular revenue and is often found in a separate section near the bottom called “Other Income.”
   5. Itemized expenses: All income statements should have a detailed list of individual expense categories. To calculate their operating profits, some companies separate their expenses into operating costs and non-operating expenses.
   6. Earnings before tax (EBT): This measures a company’s financial performance prior to paying tax. EBT is calculated by subtracting non-tax expenses from income.
   7. Net profit: Your company’s net profit is the gross profit minus expenses and is the final line on your income statement. 

Depending on industry and company policies, these components may be further divided into individual line items by project, product line, or department. 

Analysis

It’s important to know how to analyze an income statement as it can reveal the profit structure of your business and can highlight which line items need more attention. 

From top to bottom, reading an income statement can be divided into three sections: top, middle, and bottom. The top section is related to revenue and sometimes includes costs directly associated with generating that revenue.

The middle section provides information on the money going out, and this section lists expenses like marketing, depreciation, and research that aren’t necessarily direct inputs for what is sold. 

Finally, the income statement’s bottom section is the net income, which represents your company’s financial performance during a specific reporting period.

Finally, lenders or investors can analyze an income statement by completing a vertical and horizontal analysis. 

• • Vertical Analysis – This method compares one line item to another. For example, you can determine how a specific product may affect cash flow. Using vertical analysis, one can observe where a business may be overspending and which line items most contributed to profit margins. 

• • Horizontal Analysis – This analysis compares the same figures across two or more time frames, which is useful in spotting trends. For instance, reviewing a company’s consistent growth over time can predict how well that business will perform in the months or years to come.

The Bottom Line

An income statement provides valuable insights into various aspects of a business. As a business owner, you can understand the organization’s operations, the efficiency of its management, and potentially spot problem areas. 

The income statement is also an excellent benchmarking tool to see how your business stacks up to other companies within the same industry. You can determine if your costs are high for the revenue you bring in, and you can also ascertain if your profitability is worse, better or similar to other firms who sell the same goods or services.

In conjunction with the statement of cash flows and the balance sheet, income statements help management understand the complete picture of a company’s financial results to determine its value and forecast its trajectory.

 

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The three primary financial statements: balance sheet, income statement, and statement of cash flows, work together to provide a financial report of a company’s profitability during a period.  

The income statement is a business’s income within a certain period. The cash flow statement shows how much cash a business generates and where it spends that cash during a period. However, the balance sheet is a statement of a financial position at a single point in time (a particular calendar day). 

This article dives deeper into the balance sheet and details its components and significance to understand your business’s profitability and overall financial value. 

What Is a Balance Sheet?

The balance sheet provides a picture of what a business owns and owes and how much is invested. The balance sheet is commonly used for a great deal of financial analysis, focusing on a company’s assets, liabilities, and equity. By looking at these three numbers, banks, auditors, owners, or investors can learn a lot about your organization. 

In order for your balance sheet to balance, it must be divided into two sections. On the left are the company’s assets, and on the right are liabilities and equity. Shortly, we will get more granular in the differences among these critical metrics. 

First, we will look at how a balance sheet works in tandem with the accounting equation in uncovering a company’s viability. 

The Accounting Equation

The balance sheet adheres to the accounting equation where everything a business owns (assets) equals everything they owe (liabilities), plus the owner’s equity in the company.

The accounting equation states that a company’s total assets are equal to the sum of its liabilities and its shareholders’ equity. These sections of the balance sheet being “in balance” are considered to be the foundation of the double-entry accounting system.

Assets

The business owns assets that have a monetary value and are listed in order of liquidity or how readily they can be converted to cash. 

Assets are divided between current and fixed. 

Anything you expect to convert into cash within a year is called a current asset. Examples of current assets are cash balance, accounts receivable, pre-payments on future orders, and inventory. 

On the other hand, fixed or long-term assets may be more difficult to turn into cash within the year. Examples of fixed assets include land or buildings, office furniture, equipment, and goodwill. 

Fixed assets are recorded as the original purchase price of an item. A business must subtract the accumulated depreciation from these assets. 

Liabilities

Liability is the money owed to 3rd parties. These funds owed are also broken down into current and long-term categories. 

Current liabilities are expected to be paid within a year and include accounts payable, employee wages, taxes, and insurance payments. In contrast, long-term liabilities would consist of deferred tax liabilities, long-term debt such as mortgages, and pension fund liabilities.

Owners’ Equity

Owners’ equity or net assets is the amount that remains after subtracting liabilities from the assets. 

One way to think about equity is if all assets were sold and the proceeds were used to pay all liabilities, what’s leftover would belong to owners.

Equity can be in capital, private or public stock, and retained earnings for larger corporations. 

Final Takeaway

An analyst can generally use the balance sheet to calculate many financial ratios that help determine how well a company is performing, how liquid or solvent a company is, and how efficient it is with its cash.

Although the balance sheet is an invaluable piece of information, it is not the complete picture. Since it is just a snapshot in time, it can only use the difference between the current point and another single point in the past. Or in other words, this number is static. Therefore, it is beneficial to also draw on data within the income statement and statement of cash flows to paint a fuller picture of what’s going on with a company’s business.

 

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As a business owner, one of the most important factors to ascertain is how many goods or services you need to sell to cover your expenses to become profitable. This accounting metric is known as the break-even point. 

 

In previous articles, we have conveyed the importance of a business’s cash flow and developing a system around cash flow management. This is the cornerstone of running a successful business.

 

In this article, we are still concentrating on an organization’s revenue and expenses; however, we are simplifying the process down to one number. Let’s explore the intricacies of this number and how to model it for your business. 

 

Understanding Break-Even Point

 

A company’s break-even point or break-even analysis is the point at which its sales equal the cost of doing business. The organization has not made a profit yet but is not operating at a loss. 

 

Every product a company sells or service offers carries an associated cost. Whether it is the cost of the raw materials or wages to implement new software, there are always costs incurred when running a business. 

 

These costs show up as the cost of goods sold (COGS) in a production environment. The more physical products you produce, the higher your COGS. 

 

By understanding how much output is required for the company to break even, adjustments can be made accordingly. A business can adjust output as well as the sale price of their products or services. 

 

Beyond the break-even point,  all incremental revenue beyond this point contributes to the organization’s gross profit. 

 

Break-Even Point Formula

 

A break-even analysis is a formula that shows how many units of phones, chairs, legal services, etc. you need to sell to cover your costs. 

 

Calculating the break-even point involves taking the fixed cost and dividing the amount by the contribution margin per unit. To find the contribution margin per unit, take the price per unit and subtract the variable costs per unit. 

 

 

Before calculating this formula, we need to pinpoint the following three variables.

 

1. Fixed Costs – these are costs independent of sales volumes, such as rent, insurance, and loan payments. These are commonly known as SG&A.

2. Variable Costs – are expenses that fluctuate up or down per sales volume. Examples are raw materials, manufacturing labor costs, and sales commissions, which are generally part of COGS.

3. The sale price of the product or service.

 

After you can establish these numbers, you can calculate the break-even point expressed in units produced or quantity of service sold.

 

Example

 

To illustrate the break-even point, let’s assume a sock manufacturer has fixed expenses that total $10,000 per month. Their variable cost (COGS) per unit is $5 per pair of socks, and the socks retail for $25 (sale price). 

 

We first find the contribution margin, which is $20 per pair of socks. Then by dividing the fixed costs by the contribution margin, you will know how many units of socks you need to sell to break even.

 

Analysis

 

A break-even analysis is helpful whether you are just starting a business or have been operating already for several years. It is never too late to start using this new tool, and there are also a few instances where this metric becomes increasingly valuable.

 

◦ Before starting a business – it is essential to conduct this financial analysis when developing a business plan. Then you will have a good idea of the risks involved. 

◦ New product or service – existing businesses should conduct this analysis before launching a new product to learn how it will affect profitability. You might discover you will need to sell too many units to cover your overhead. 

◦ Performing a break-even point for a new product may help determine the right price for the item. 

◦ Changes in manufacturing – a business is considering outsourcing a portion of their manufacturing. Suppose the organization can produce the same quality with a lower variable cost but isn’t sure if working with a partner would increase the fixed cost. In that case, this analysis will play a critical role in determining if the change would be cost-effective. 

 

All businesses want to be as profitable as possible. Calculating the break-even point is just one component of cost analysis, but it is often an essential first step in establishing a retail price point that safeguards a profit.

 

Conducting a break-even analysis is a powerful tool for planning and decision-making. Performing this calculation on a long-term basis can identify critical information like price variability, setting appropriate sales targets, and highlighting weaknesses in the current business model. 

 

How FINSYNC Can Help

 

FINSYNC allows you to run your business on One Platform. You can send and receive payments, process payroll, automate accounting, and manage cash flow. To learn more about how we can help your business start, scale, and succeed, contact us today.

All businesses need to track each and every cost within the organization meticulously. This is why understanding the cost of goods sold is such a vital component of your company’s success. 

 

Cost of goods sold (COGS) refers to the direct costs of producing the goods sold by a business. 

 

This article concentrates on the accrual accounting method within production-based industries. Service industries are not considered as they do not retain inventory, and COGS mainly looks at the cost of inventory items sold during a given period. 

 

The cost of goods sold is recorded in the income statement, also known as the profit and loss (P&L) statement. We will learn what is included, how COGS differs from operating expenses, and how to calculate it. 

 

Included in COGS

 

When determining COGS, a good rule of thumb is to ask the question–Would the cost exist if no products were produced? If the answer is no, then there is a good chance that cost is part of the cost of goods sold. 

 

Cost of goods sold examples:

 

◦ Raw materials

◦ Electricity to run the assembly line

◦ Labor needed to make a product

◦ Storage of products

◦ Processing

◦ Other overhead costs for running the production facility

 

Do not factor things like administrative costs or other expenses into the cost of goods sold since our only focus is on production costs.

 

Operating Expenses vs COGS

 

Both operating expenses and cost of goods sold are expenditures a business incurs to create goods and services. However, unlike COGS, operating expenses are not directly related to the production of goods. 

 

Operating expenses are SG&A: selling general, and administrative expenses. These are costs to keep the business open that would occur regardless of how many products are produced. Here are some examples below.

 

Operating expenses examples:

 

◦ Rent

◦ Office supplies

◦ Sales and marketing 

◦ Insurance

◦ Equipment

◦ Legal costs

 

Businesses within the production industry need to budget for operating expenses even though they don’t directly affect production costs. 

 

Calculating Cost of Goods Sold

 

Here is the general formula for calculating COGS

 

 

We will take a deeper dive into this formula as there are four steps involved in performing this calculation. 

 

1. Identify the beginning inventory of raw materials and completed goods, which are the previous period’s ending inventory. 

2. Determine the total cost of purchases for any raw materials and parts used in production.

3. Find ending inventory – determine the total value of all items in inventory at the end of the period.

4. Total all other direct costs of production, including labor, shipping, and variable costs.

5. This calculation is based on the change in inventory between accounting periods. The result is the cost of the inventory made and sold by the company during the year.

 

FIFO and LIFO

 

Inventory is the biggest business asset within production-based organizations, which directly affects gross profit. Inventory valuation allows you to evaluate your Cost of Goods Sold (COGS) and your profitability. The most widely used method of inventory valuation is FIFO & LIFO.

 

Since COGS subtracts ending inventory from the beginning, any change in the value of products over time could drastically alter our final calculations. Here is where FIFO or “first in, first out” comes into play.

 

FIFO assumes that the oldest items in the inventory were the first to be sold for accounting purposes. This does not mean that the oldest items are always sold first, but this assumption simplifies the accounting process.

 

LIFO, or “last in, first out,” is the opposite of FIFO. Last in, first out assumes the newest items are the first to be sold. This inventory method can offer companies significant tax advantages if a company’s inventory costs are rising. 

 

An example of older inventory affecting valuation is seen with new car sales. A newly arrived car is worth more than a similar model that has been sitting on the lot for the past 8 months. Therefore, the longer a car is in inventory, the lower the value is over time. 

 

Using LIFO, an increase in the product’s value over the period would result in the cost of goods sold being skewed toward a higher value and vice versa if the product’s value dropped.

 

Overview

 

Tracking your cost of goods sold regularly will give you a lot of information about the productivity of your business. You will be able to tell if you are paying too much for raw materials or labor. You can also determine if you need to change the price of your finished product. 

 

Moreover, COGS determines the profitability of your organization and is subtracted from a company’s revenue to determine the gross profit. The cost of goods sold is a direct indicator of how efficient a company is in managing its labor and supplies in the production process.

 

Lastly, you can take advantage of the COGS deduction on your tax return. You will need to keep meticulous records throughout all manufacturing and inventory expenses incurred during the production or acquisition of sold goods.

 

How FINSYNC Can Help

 

FINSYNC allows you to run your business on One Platform. You can send and receive payments, process payroll, automate accounting, and manage cash flow. To learn more about how we can help your business start, scale, and succeed, contact us today.