Have you started a business and been selling products or services for a few months? Have you started charging customers (*1)? Then comes the moment that most entrepreneurs fear, the time to do their taxes (*2).
Being in business is much more complex than being a simple employee and requires some knowledge. Every entrepreneur is required to maintain accounting records and produce financial statements each year. In fact, Revenu Québec and Revenue Canada may, at any time, require seeing the financial statements of a company and examining its accounting records.
To better understand and anticipate your entrepreneurial obligations, find out more about the challenges and details of a company's financial statement.
What is the financial statement of a company?
The financial statement is an accounting document that lists a great deal of information about a company’s financial situation. It consists of many essential components, with the main ones being:
- Income statements,
- The balance sheet,
- Retained earnings statement,
- Financial statement notes,
- Cash flow statements
The income statement and balance sheet are two essential components with a process that is important to understand. Each of them, in the same way as accounting charters or the trial balance, consists of five different types of bookkeeping accounts, which are:
- Equity and retained earnings
A company’s income statement
The income statement is one of the most important components of a company's financial statement, if not the most important. This is composed of income and expenditure accounts.
In the income account, we find information such as your sales, rental income or investment income, including interest, dividends and capital gains.
On the other hand, with regard to the expenses account, we find information such as your purchases, remittance to your subcontractors and your employees, hiring expenses, travel expenses or representation expenses.
The mathematical equation of the income statement is relatively simple since it consists of subtracting expenses from revenues. Essentially, it indicates how much revenue/sales we made during the year as well as all the expenses we incurred during our fiscal year. This provides us with the profit or loss incurred during the year. In addition, it is important to know that the income statement is reset every fiscal year, on an annual basis.
Its purpose is therefore to inform us about the money we make with our operations, that is to say the profit on which entrepreneurs will be required to pay taxes for their company.
The balance sheet in a company’s financial statement
Equally essential in the preparation of the financial statement of a company, the balance sheet lists all the assets and debts of a company to determine its net worth.
This resembles a personal balance sheet. It's a bit like a snapshot of a company’s financial health at a given date. In effect, as of December 31, you will be able to determine how many assets and liabilities (debts) you have, as well as the value of your business.
This component of a company’s financial statement consists of different accounts, which are assets, liabilities, as well as equity and retained earnings.
In the assets, we find information such as the bank account, receivables, in-stock inventory and capital assets (computer equipment, office equipment, car, building).
In terms of liabilities, this account lists all the items that must be paid by the company, i.e. accounts payable, loans, taxes, as well as credit cards and line of credit.
Finally, the shareholders’ equity and retained earnings statement lists information such as share capital, retained earnings at the beginning of the year, or income for the year (profit or loss).
The mathematical equation of the balance sheet is therefore equivalent to the sum of the asset accounts being equal to the sum of the liability accounts, as well as the shareholders’ equity and retained earnings accounts.
Difference and relationship between income statement and balance sheet
As mentioned earlier, the income statement provides you with the financial profit or loss of your business activities for a given period. It is therefore not associated with a specific date, but rather corresponds to a report drawn up over a period, which may be, for example, from January 1 to December 31 of the same year. Conversely, the balance sheet is a portrait of the company’s financial health at a given date, for example, when drawing up the financial balance sheet on December 31.
Moreover, in a company’s financial statement, the income statement must be reset at the end of each given period. To do this, the amount of the "income from the year" account must be transferred to the "retained earnings" account of the balance sheet at the end of each period.
Specific case of a business owner
In order to best illustrate the importance and function of the two main components of a company's financial statement, namely the income statement and the balance sheet, we present you with a simple example.
Consider that a company made a profit of $10 in its first year and a profit of $20 in its second year. This company’s financial statement, at the end of its second year, will be presented as follows:
- Sales $30
- Salaries: $5
- Office expenses: $5
- Bank account balance: $40
- Accounts receivable: $6
Total assets: 46$
- Accounts payable: $10
- Tax payable $5
Equity and retained earnings
- Common shares: $1
- Retained earnings at the beginning of the year: $10
- Net profit for the year: $20
Total liabilities + shareholders’ equity and retained earnings: $46
We therefore note that the profit in the income statement corresponding to revenues less expenses is reported in the balance sheet under the “net profit for the year” account. Moreover, the sum of the balance sheet's active accounts is equal to the sum of the liability accounts as well as the shareholders' equity and retained earnings.
It is therefore essential to understand that the balance sheet is always in continuity, year after year. It never goes back to zero like the income statement does. In addition, a company's closing balance sheet for a fiscal year is always used as the opening balance sheet for the following year.
In conclusion on the financial statement of a company
It is therefore essential for entrepreneurs to keep their accounts up to date and this includes preparing the company’s financial statement. In doing so, you will be in good standing in case of an audit and also have an overall view of your company, estimate its real value and determine the profits generated.
If you want to benefit from the support and advice of a tax accountant, contact the T2inc team now. We will ensure that you receive honest and accurate answers to all your questions.
*1: Remember that if you have billed customers and your revenues are $30,000 or more in a period of 12 consecutive months, regardless of the period, you are required to register for the GST/QST. To do this, you must request your tax numbers from Revenu Québec if you are in Quebec or Revenue Canada if you are located outside the province.
*2: If you are doing business under your own name as self-employed, sole proprietorship or partnership, business tax time arrives along with your personal taxes. You only need to complete additional appendices that are attached to your personal tax return. The form number is T2125 at the federal level and TP-80 at the provincial level. Self-employed persons must pay their taxes by April 30, like all other individuals, however, they have an additional period of time to file their T1 tax return, which runs until June 15 of each year.
On the other hand, if you are doing business as a corporation, which is also known as an incorporated entity or incorporated company, you have six months after the end of your fiscal year to file your taxes. For example, if you joined on April 15 and chose March 31 as the end of the fiscal year, you will have until September 30 to file your T2 and CO-17 corporate income tax returns.