From time to time, I come across small business owners that do not understand their financial statements. Moreover, they use the wrong words to describe the fundamental economic situation in the business. Let me clarify a few basic terms related to your financial statements.
- Sales and Revenue are synonymous and mean the ‘top line’ of the income statement (profit and loss statement) – the money that comes from the customers.
- Profits, Earnings and Income are all synonymous and mean the ‘bottom line’, or what is left over from Revenue after all the Costs and Expenses spent in generating that Revenue are subtracted.
- Costs are money (mainly for materials and labour) spent making a product. Expenses are money spent developing it, selling it, accounting for it, and managing this whole making and selling process.
- Both Costs and Expenses become Expenditures when money is actually sent to vendors to pay them.
- Orders are placed by customers and signify a request for the future delivery of products. Orders do not have an impact on any of the financial statements in any way until the products are actually shipped. At this point, the Shipments become Sales. The words Shipments and Sales are synonymous.
- Solvency means having enough money in the bank to pay your bills. Profitability means that your Sales are greater than your Costs and Expenses. You can be profitable and insolvent at the same time. You are making money but still do not have enough cash to pay your bills.
I hope that will help you to understand the basic terms of financial statements.