The Profit & Loss Statement records how much value has been created (or destroyed) in carrying out day-to-day business activities. It has to be read in conjunction with the Balance Sheet to understand how of that value actually translated to cash.

The financial statement that best illustrates this relationship between Profit & Loss and Cash is the Cash Flow Statement but for some strange reason, this statement is rarely produced as part of monthly accounts and always the least understood financial statement.

However, in order to understand this ‘mysterious’ Cash Flow Statement, let’s first look at the Profit & Loss Statement and how it relates to the Balance Sheet.

 What is a Profit & Loss Statement

The Profit & Loss Statement, as its name suggests, shows:

1. How much money the business earned
2. How much it cost the business to earn the money
3. The net result of (1) and (2) which is a profit or a loss depending on whether (1) is greater or less than (2)

It’s not about money that the business received from its shareholders or that it borrowed. Those are called as “financing activities”. It’s not about money that the business spent on buying equipment or chunky assets that will help it create earnings over time eg buying computers, card, buildings etc. These are termed capital expenditure or “investing activities”. The Profit & Loss is about “operating activities”.

If you think of the Balance Sheet as the “eco-system” of the business, the business transactions that are recorded in the Profit & Loss are ‘invaders’ of that eco-system. Each transaction alters the composition of the Balance Sheet but as discussed in Part 1 of this series, this “eco-system” always remains balanced.

 How does the Profit & Loss affect the Balance Sheet

As explained in Part 1, ‘every action has an equal and opposite reaction’ in accounting. Everything that happens in the Profit & Loss has an equal and opposite reaction in the Balance Sheet.

Let’s use the example of a business that sells widgets. The business has a widget in its inventory (Asset) that cost it $10. It paid for this by borrowing (or owing the supplier) $9 and the business owner put in remaining $1 (equity) which is represented as follows:

Assets ($10) = Liabilities ($9) + Equity ($1)

The Transaction

It sells the widget for $20. Two events have happened here: first, a $10 widget went out of the ‘system’; and almost simultaneously, $20 came into the system. The action and reactions are recorded as follows:

(a)   Record the widget going out of the system

• Deduct $10 from Inventory (Asset)
• Add $10 to Cost of Goods Sold ($10) in the Profit & Loss Statement.

At this point, the Balance Sheet is still out of balance because the 2^nd entry is “extraneous” to the eco-system (Balance Sheet).

Assets ($10 – $10) < Liabilities ($9) + Equity ($1)

The Sales transaction itself then has to be reflected in the balance sheet. How the sales transaction affects the balance sheet will depend on whether it was a cash or credit sale.

 (b)   Record the sales transaction

• Add $20 to Sales in the Profit & Loss
• Add $20 to Cash (Asset) OR Add $20 to Debtors (Asset)

But the Balance Sheet is still out of balance because more value ($20) came into the system than went out ($10) of the system.

Assets ($10 – $10 + $20) > Liabilities ($9) + Equity ($1)

The net effect of the transaction (profit or loss) on the balance sheet has to be recorded as well to bring the Balance Sheet back to equilibrium. Profit belongs to the owner of the business, so it forms part of Equity.

What actually happens here is that the $10 profit gets ‘transferred’ from the Profit & Loss Account across to the Balance Sheet. The Profit & Loss account is a sort of “pass through” vessel rather than a store of value. The Balance Sheet is where value created in the business is stored.

(a)   Record the profit.

• Take $10 from the Profit & Loss
• Add $10 to Equity in the Balance Sheet.

So now you have additional value of $10 that was generated by trading activities showing up in the Balance Sheet:

Assets ($10 – $10 + $20) = Liabilities ($9) + Equity ($1 + $10)

 Why Profit is NOT Cash

Consider what the equation looks like for sale on Cash and Credit terms respectively:

Cash Sale:    Cash ($20) = Owing to Supplier ($9) + Equity ($1) + Profit ($10)

Credit Sale:   Debtor ($20) = Owing to Supplier ($9) + Equity ($1) + Profit ($10)

If the Debtor doesn’t pay you, the Asset side of your Balance Sheet goes to $0. The opposite side of this vaporisation of the Debtor asset is the recording of a Bad Debt expense of $20 in the Profit & Loss Statement.

Assets ($0) < Owing to Supplier ($9) + Equity ($1) + Profit ($10)

When we first recorded the sale transaction, we transferred the profit of $10 from the Profit & Loss to the Balance Sheet. So the Profit & Loss was an empty vessel until the $20 loss (Bad Debt Expense) was recorded in it.

Just as we transferred the profit of $10 to the Balance Sheet earlier, we now transfer the $20 loss to the Balance Sheet. This shows the net loss of $10 on the transaction from go to whoa.

Assets ($0) = Owing to Supplier ($9) + Equity ($1) + Loss ($10 – $20)

The equation is now back in balance but it’s a pretty ugly picture. You’ve got no cash, you have no widget and you still owe the supplier $9 and you’ve lost your $1. So you are going to have to come up with another $9 in cash of your own money to pay the supplier eventually.

This very simple example should underscore two critical business issues:

• Profit is not cash
• A sale is not a sale until you’ve collected the money

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Siu Ling Hui, the founder of In-Context Finance, is a successful financial consultant who helps to small and medium sized businesses (SMBs) with obtaining debt finance and equity funding to achieve their business objectives. She also assists business who are in financial trouble to get back on track. Her blog Ruminations by In-Context Finance provides practical business advice for SMBs.

Thank you for subscribing to Internet Business Mastery feed. For instant access to your free audio gift and a risk-free trial of our proven step-by-step program for starting your own profitable internet business, please visit http://www.freeaudiogift.com.

There’s websites to build, preparation for product launches, social networking and so on. In comparison to all these other activities, dealing with accounting and finance matters sounds about as appealing as a visit to a dentist.

Sound financial management practice is the business equivalent of a good dental health regime. Without it, decay will set in and there’ll be very unpleasant drilling and extraction work by the “dentist” in the form of the tax office, creditors, banks etc.

I have seen many young fast growing businesses falling over because they didn’t have sound financial management practices in place. Ironically, it is when rapid business growth happens that the financial cracks emerge.

THREE FINANCE BASICS FOR NEW BUSINESSES

Get an accountant

Unless you are an expert in accounting and tax, an accountant is one of the key advisors that your business must have on an on-going basis.

Choose a good reputable accountant. Not all accountants are created equal. I have come across some who not only charged like wounded bulls but also provided bad advice. Get recommendations from trusted sources if you don’t know who to go to.

Meet with your accountant before you even commence trading. At this meeting, find out about all the regulatory, tax and other compliance matters that apply to your business such as:

• What are the federal, state and local taxes that apply to your business?
• Do you have to add value added tax (VAT) or goods and services tax (GST) to your services or products? You need to allow for these in your pricing or you’ll end up eroding your profit margins!
• When do you have to do filing of returns and payment of these taxes?
• What kind of record keeping systems should you have for your business? Should you be accounting on a cash or accrual basis?
• Do you have to contribute to pension (superannuation) funds?

Separate personal from business finances

Your business must be treated as a separate and distinct entity from you as an individual.

Open a separate bank account. Only business transactions go through that account. You can only take money out of the business as salary, loan or dividend or partnership drawing (depending on the legal structure). There are different accounting and tax implications for each.

Keep a separate credit card for your business. If your business does not qualify for its own business credit card, choose one of your own cards to use solely for business purposes. Credit cards can be fantastic cash flow management tools for small businesses IF they are properly used.

Why separate personal from business finances?

(a) administrative efficiencies (you don’t want to spend hours trawling through bank or credit card statements trying to identify what is personal and what is business) ; and

(b) clarity for business cash flow planning and management

Plan and manage cash flow

There’s an old saying: “Profit is Opinion. Cash is Fact.” Cash flow is the life blood of a business. Failure to understand and manage cash flow is the most common killer of businesses, large or small.

Cash flow planning and management must be done at  2 levels:

• Strategic or “working ON the business” level; and
• Day-to-day or “working IN the business” level

Even if you have a strategic plan with a full-blown 3-way financial forecasts, day-to-day cash flow management is still essential because cash flow is all about timing. You must ensure that there’s always enough money to pay bills when they are due. Do this with a simple tool that goes by the fancy technical name of “rolling weekly cash flow forecast”. You can set it up on a spreadsheet (recommended) or on a whiteboard.

What is a Rolling Weekly Cash Flow Forecast?

• Detailed week-by-week forecast of expected cash receipts and payments, and the expected bank balance at the end of each week
• Forecast period of 8 to 12 weeks out, and
• Updated every week so you always have visibility into expected weekly cash flow for the coming 8 to 12 weeks (hence the name “rolling”)

Caution! If your business provides refund guarantees on its products, the money that you receive from these sales is NOT yours to use until the guarantee period is up. DO NOT USE THIS MONEY. Isolate it from your “available to use” funds. Either  physcially transfer the money into a separate at-call interest bearing account or as an adjustment to available bank balance in your forecast spreadsheet. Likewise with any VAT, GST or other taxes included in your collections: you have to pay these to the relevant authorities at some point.

Even if you outsource the actual grunt work of the finance and accounting function, you must understand the finances of your business to ensure it survives and thrives in the long term. Get advice or coaching to help you master this essential business skill.

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Siu Ling Hui, the founder of In-Context Finance, is a successful financial consultant who helps to small and medium sized businesses (SMBs) with obtaining debt finance and equity funding to achieve their business objectives. She also assists business who are in financial trouble to get back on track. Her blog Ruminations by In-Context Finance provides practical business advice for SMBs.

Thank you for subscribing to Internet Business Mastery feed. For instant access to your free audio gift and a risk-free trial of our proven step-by-step program for starting your own profitable internet business, please visit http://www.freeaudiogift.com.

4.  Use The Proper Written Agreements with Contractors and Employees

The single most important practice you should put in place for your business is to use written agreements with the employees and contractors who you deal with.

If you ignore this step, you may not even obtain ownership/title to the very thing you paid someone else to create for you, and could even end up owing that person royalties later.  Or worse yet, you could end up in a dispute with the other party because of unclear terms.

The agreements do not have to be complicated, and there are numerous products that you can purchase that come with simple agreement templates you can use with employees and contractors (such as our BizShield product: http://www.businessthrival.com/ourproducts/).

The reason that it is so important that you get a written agreement with contractors and employees is because of the way the intellectual property laws work.  It’s a bit complicated, but the simple version is the contractor/creator owns the copyright in the work that you pay them to produce, unless they transfer that copyright over to you in a written agreement.  So in plain English, this means that a web developer or graphic designer or other type of contractor who you hire will retain the copyright ownership in the work you pay them to produce, unless you get them to sign an agreement transferring those rights over to you.  This may sound backwards, but that is the way the copyright laws work.

With your employees, you automatically own the copyright interests in the work you pay them for, but not their patentable ideas.  So that’s why it is important that you also get a written agreement with your employees.

Here are the most important terms that you should consider including in your contracts with employees and contractors:

• An intellectual property ownership clause stating that your company will own all intellectual property that they produce while working for you, including source files, source code, patent, and copyright interests
• A confidentiality clause stating that they will keep the non-public details of your company in confidence
• A clause specifying how much they will be paid
• A clause specifying how long the relationship will last, or that either party can terminate it at any time

5.  Follow The Proper Accounting Principles To Keep Your Business In Good Standing

This accounting guideline is one that no one ever likes to follow, but is just as important to mention as the others covered so far.

It is critically important that you follow the proper accounting procedures to keep your business in good standing.  Here are some examples of what those proper accounting procedures involve:

• Make sure you maintain your business records totally separate from your personal records
• Never pay personal bills out of a company checking account.  For example, you shouldn’t make your house payment from a corporate checking account.
• If you pay for something personally (such as cash or on a personal credit card) that is for your business, make sure you submit an expense report to your company with the receipts attached, and get reimbursed.
• If possible, use an electronic accounting system to enter your income and expenses throughout the year as you go along.  This will make preparation of your taxes much easier, and also will make it easy for you to prepare financial statements for your bankers whenever you are requesting loans, etc.

Here are the most common pitfalls that can arise if this is not done correctly:

• If you co-mingle your personal and business funds together, for example, then you may lose the protection offered by your limited liability company (assuming you formed one).
• If you don’t follow good accounting practices, it will make preparation of your tax returns as well as financial statements for bankers tons more time consuming.  Without an electronic accounting system, it could take days or even weeks to complete what would take only minutes with an electronic accounting system.

So there you have it.  Those are the 5 most important steps you should take to setup a solid foundation for your new business.  And if you implement these in your business, you will save yourself from some of the biggest pitfalls that could have caused you serious problems.

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Denise Gosnell is an attorney, entrepreneur, and 8-time author with Wiley Publishing.  She is the CEO of Business Thrival, Inc., a company dedicated to helping business owners obtain a thriving business and live, by providing a free Business Thrival Blueprint, weekly newsletters, and quality products.

Thank you for subscribing to Internet Business Mastery feed. For instant access to your free audio gift and a risk-free trial of our proven step-by-step program for starting your own profitable internet business, please visit http://www.freeaudiogift.com.

1.  Form a Company With Limited Liability Protection

Any time you start operating a new business, you should carefully consider what type of legal entity will best protect the operations of that company and your personal assets.  It is nearly always a good idea to choose an entity that offers some form of limited liability protection, such as an LLC or Corporation.

No matter what you do, think long and hard before you ever operate as a sole proprietor, because that subjects you to unlimited personal liability.  In other words, if you operate as a sole proprietor and your business ever does something wrong or gets sued, a creditor could go after your personal house, savings, car, or other personal assets.

But if you operate your business under a limited liability shield, such as a corporation or LLC, then the only assets the creditor could get are the assets of the company.

To file a new corporation or LLC, you generally file the proper formation documents with the Secretary of State in the state where you want that company formed.  Most Secretary of State web sites have online forms that you can download and then submit interactively.

We have compiled an index of Secretary of State web sites at: http://www.businessthrival.com/sos/

You can use this index to quickly locate the Secretary of State web site for your state.

2.  Choose The Proper Name For Your Business and Products

Before you actually incorporate your business, it is a good idea to do some basic research to pick a name that someone else is not already using to sell similar goods and services as you.  In other words, you do not want to start your new business off with a name that could cause you to be sued for trademark infringement because you chose a name that someone else already owns.  You can think of this as “having all your ducks in a row”.

Trademark law is designed to protect consumers from confusion between different companies.  Trademarks identify the source of that product or name.

This means that any time you choose a company name, product name, or slogan, it is important that you do some initial research to make sure that someone else is not already using that name or a very similar variation of it in a way that would cause consumers to be confused between your two companies.

It is usually fine for companies in two totally different industries to have the same name, because no one would get them confused (unless it is a famous trademark, where that company retains rights across all industries).  But if you use a product or company name that is confusingly similar to another company who has a superior interest in that name, they could sue you for trademark infringement and possibly obtain significant money damages.

One place to start your research is the United States Patent and Trademark Office trademark database.  You can also search Internet search engines to see if you find anyone else who is already using your preferred name or a similar name in a similar industry.

Then, as you move forward with your business, you will want to make sure that you mark your trademarks with ™ (the TM sign) to designate that you are claiming an interest in the brand/name.  If you obtain an actual federal trademark registration, then you can start using ® (the circle R designation).

3.  Obtain the Necessary Licenses

Another step that you need to consider in setting up your new business is whether you need any special licenses in order to operate.

Some types of businesses require a special license to operate, such as a daycare, insurance agency, law firm, or doctor’s office.  If you are in the type of business that requires a special license, you are probably already aware of that through the licensing process that you had to go through in order to obtain that specialty.  It is still worth spending a few minutes to do extra research to make sure that your type of business doesn’t require any additional licenses.

The most commonly overlooked license is a sales tax license.  If your business is going to sell products, then you are likely required to collect sales tax for any of those products that you sell to customers in your state.  In most states, you do not have to collect sales tax on services.

You should check with your state’s Department of Revenue in order to determine what exactly you have to collect sales taxes on, if anything.

We have put together a sales tax index to help you locate your state’s Department of Revenue more quickly.  You can find it here:

http://www.businessthrival.com/sales-tax-license-information/

More to come in Part 2, check it out HERE!

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Denise Gosnell is an attorney, entrepreneur, and 8-time author with Wiley Publishing.  She is the CEO of Business Thrival, Inc., a company dedicated to helping business owners obtain a thriving business and live, by providing a free Business Thrival Blueprint, weekly newsletters, and quality products.

Thank you for subscribing to Internet Business Mastery feed. For instant access to your free audio gift and a risk-free trial of our proven step-by-step program for starting your own profitable internet business, please visit http://www.freeaudiogift.com.

For those who still need to be brought up to speed, we have two new audio promos for the podcast. Now we we want to see your creativity! We’re looking for talented listeners to make a video using one of our new audio promos as a soundtrack.

Anyone who creates a video will get download access to three audio interview programs with top internet masters, Tim Ferriss, Brian Clark and Andy Wibbels. One video will be chosen to win the grand prize including:

1. A review of your site or business plan by Sterling and Jay (you can’t buy this kind of consulting from us)
2. $100
3. A special Internet Business Mastery Unemployable T-shirt
4. A special Internet Business Mastery Unemployable Mug

The deadline to enter is December 31st at midnight Eastern Time. Click here to download the promos, read the rules and get the full details on the prizes. Good luck!

Thank you for subscribing to Internet Business Mastery feed. For instant access to your free audio gift and a risk-free trial of our proven step-by-step program for starting your own profitable internet business, please visit http://www.freeaudiogift.com.

Her blog is also an excellent example of using quality content, social media and pull marketing to promote your services and establish your brand as an expert online. At the time of writing this post, a Google search for new york small business law turns up here site at the top.

Thank you for subscribing to Internet Business Mastery feed. For instant access to your free audio gift and a risk-free trial of our proven step-by-step program for starting your own profitable internet business, please visit http://www.freeaudiogift.com.

This is the second part of the interview where we sit down with Darius Barazandeh who is a business attorney, internet entrepreneur and real estate investor. We pick Darius’ brain to find out how you can protect your assets and get the best tax advantages with your business entity.

If you want to get your hands on all of Darius’ tips for starting your own LLC, all the documentation you need to start your own business entity and free email consulting with Darius himself, click here.

Jay talks more about how your web site URL can make or break your search engine marketing results.

Links to things mentioned in this episode:

Getting Things Done by David Allen

Thank you for subscribing to Internet Business Mastery feed. For instant access to your free audio gift and a risk-free trial of our proven step-by-step program for starting your own profitable internet business, please visit http://www.freeaudiogift.com.

In this episode we sit down with Darius Barazandeh who is a business attorney, internet entrepreneur and real estate investor. We pick Darius’ brain to find out how you can protect your assets and get the best tax advantages with your business entity.

Darius reveals tips such as:

• How to avoid wasting money on lawyer’s fees
• How soon an internet business should form an LLC
• The areas of liability risk that an internet entrepreneur needs to be aware of
• How to avoid business liability from affecting your personal assets
• The dangers of partnerships and how to avoid them
• When an LLC makes sense over other available business entities
• Why just registering an LLC is not enough to create/preserve liability protection

If you want to get your hands on all of Darius’ tips for starting your own LLC, all the documentation you need to start your own business entity and free email consulting with Darius himself, click here.

Jay also gives an Internet business quick tip on how your web site URL can make or break your search engine marketing results.

Thank you for subscribing to Internet Business Mastery feed. For instant access to your free audio gift and a risk-free trial of our proven step-by-step program for starting your own profitable internet business, please visit http://www.freeaudiogift.com.

It’s important to take care of the basics and set the foundation as you build your road to financial freedom on the Internet. In this episode we talk about the different kinds of business entities (LLC, S-Corp, C-Corp & Partnership). We discuss the ins and outs of starting your own business entity and questions such as:

• When should you create a business entity?
• How do you create a business entity?
• Why should you create a business entity?
• What is the hidden benefit of starting a business entity now (Hint: it’s part of the success mindset)
• Which is better…an S-Corp or LLC?
• and more…

Disclaimer: We are not lawyers or accountants. We do not render professional advice in this podcast. You are responsible to do your own research and make your own decisions. We are simply sharing our experiences.

Thank you for subscribing to Internet Business Mastery feed. For instant access to your free audio gift and a risk-free trial of our proven step-by-step program for starting your own profitable internet business, please visit http://www.freeaudiogift.com.