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Budgeting Essentials Blog

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Good Financial Statements use Matching!

Last week I talked about “Is Why does my accountant seem so formal?”.   If you missed that post, you can review it HERE.  This week’s post is “Good Financial Statements use Matching!”  One of the rules that accountants have to follow is the Matching principle.  Following this principle helps keep your income statements accurate and helps your decision making process.  Learn more in this week’s blog.

 

As a small business owner, there will be times that you need to provide mid-year financial statements for various purposes.  Even though they are mid-year reports, you want them to be as accurate as possible.  An important accounting principle that you want to make sure you have followed when you are preparing those statements, is the matching principle.

Here is the formal definition: “the matching principle states that expenses should be recorded during the period in which they are incurred, regardless of when the transfer of cash occurs.”  Now let’s make that a little clearer.  You need to report the income and expense items that are related to each other in the same period.

Here is an example.  Let’s say your business buys materials and installs them.  You get paid right away for the job, but you don’t have to pay for the materials for the job until 30 days later.  If you didn’t follow the matching principle, in the first month you would show a big profit related to that job.  Then in the second month you would show a big loss.  The profit your are reporting for both months is wrong, the correct profit is a number between the two.

The reasoning behind this is important.  Decisions are often made based upon your income statement.  A decision made in the month with just revenue reported will be wrong on the optimistic side.  You could conclude, “We are doing great, let’s spend that money!”.  A decision made in the month that only the expense is reported will be just the opposite.  This time you might conclude “We are not doing very well at all.  Look at how much money we are losing!”.  The truth is going to be between these two extremes.  The expense offsets the revenue, giving you (normally) a profit.

The example that I used was very simple.  There was only one revenue item and one expense item.  You could easily have looked at the report and noticed that there were items that were missing in both months.  In the real world, you have multiple items going on each month.  It is more difficult to glance at the report and see that there are missing items.  This is where good record keeping comes in.  You need a system that helps you keep track of items that go together.  It doesn’t have to be fancy or even electronic.  While accounting programs are helpful, you could just keep a checklist that lists your jobs.  As you record the income, you put a check in the income column and as you record the expense, you put a check in the expense column.  A quick scan of the report will reveal whether you need to record any additional items to make sure you have your revenue and expense matched properly.

Good financial statements support good decision making.  Keep the matching principle in mind when you are preparing your financial statements!

If you know someone this post will help, please share it with them!  Then scroll down to the comments section and leave me a comment on this post.  If you aren’t already a subscriber, sign up to receive notification emails and information on other promotions!

God Bless your week!

Copyright

© 2018 Dan Heiland 2018 Kat Heil, LLC

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