No other business term is so misunderstood, misstated, misleading or deceiving as the words ‘net profit’. Accounting defines net profit as the amount earned after all associated costs and expenses are subtracted from the associated sales. The larger or more public the company the more reliable the dollar value as stated on the bottom line. But in small business, the more likely the value is inaccurate as stated in the financial report.
Cash basis refers to a form of accounting whereby only the cash in from sales and cash out for expenses are recorded to the books of record or in the financial reports. In general, cash basis excludes accrual adjustments as promulgated by Generally Accepted Accounting Principles.
Financial statements serve the purpose of presenting economic activity and status related to a particular date and over a particular time frame. Accountants record monetary transactions and via financial reports present the information in an easy to understand format. The financial statements for a small business do not have to comply with those of publicly traded operations.
Accounting’s primary purpose is to measure economic activity. There are several different methods to determine the economic value generated in your business each year. In accounting this is referred to as sets of books. There are four basic sets of accounting books. Each has a different purpose and end goal.
This is the most often asked question by all new businesses. Should I be on the cash or accrual basis of accounting for tax purposes? The common layman would always answer ‘CASH BASIS’ for tax purposes. They say this because they understand that you only pay the tax on the cash that you keep. But for us tax preparers and authorities on this subject, the answer is ‘IT DEPENDS’.
Code Section 465 of the Internal Revenue Code defines ‘At-Risk’ as the financial value the taxpayer has in jeopardy related to the business activity the taxpayer is invested in as some form of an owner. Effectively, the taxpayer may only take losses on his tax return contingent on the loss being directly tied to invested dollars with some form of tax basis.
‘Fixed costs’ is a business term used mostly in cost accounting. It has several meanings based on its usage. The most common definition associated with fixed costs is expenses that must be paid regardless of production or sales volume. The best example is rent for a company. It doesn’t matter whether you produce or sell one widget or several thousand, the rent must still be paid.
So why is it important to understand fixed costs? How is it used in cost accounting and in financial reporting? Finally, what are examples of fixed costs?