Accounting in business

The tools you have met so far scale from a garage hustle to the biggest companies in the country. What changes is the size of the numbers, the rules that apply, and how many strangers are relying on the reports being right.

The corner cafe

A small cafe lives and dies by three reports. The profit and loss tells the owner whether $38,000 of monthly sales survives $11,000 of ingredients, $9,500 of rent and $14,000 of wages, leaving $3,500, or does not. The balance sheet tracks the machines, the stock, and the loan that bought the fitout. And the cash flow report tracks the actual money moving, because rent is due on the first of the month whether or not the weekend was busy. Profitable businesses can still die by running out of cash at the wrong moment, which is why owners watch all three.

The gap between profit and cash is worth seeing with numbers. Suppose the cafe's profit and loss shows that $3,500 profit for the month, a good result. But three catering invoices worth $6,000 have been sent and not yet paid, the quarterly rent bill fell due all at once on the 1st, and a bulk coffee order was paid up front. On paper the month made money. In the bank, more went out than came in, and for a week the account is dangerously thin even though nothing is actually wrong with the business. That is why the cash flow report sits alongside the other two. Profit tells you whether the model works. Cash flow tells you whether you survive until it pays off. These figures are illustrative, but the squeeze is the single most common way small, profitable businesses die.

The rules of the game in Australia

• A genuine business needs an ABN, an Australian Business Number, which identifies it to the tax office and to other businesses.
• Hobby income and business income are treated differently for tax, so someone whose hustle becomes regular and organised needs to know which side of the line they are on.
• GST registration becomes compulsory once turnover reaches $75,000 a year. Below that, it is optional.
• Records explaining transactions must be kept, generally for five years.

The line between a hobby and a business is not about how much you enjoy it. It is about whether you are operating in a businesslike way: repeatedly, for profit, with some organisation and records. A student who sells a few old games online now and then is almost certainly pursuing a hobby, and the proceeds are not taxed as business income. The same student running a regular reselling operation, buying stock to sell on at a margin week after week, has crossed into business, and with that come the ABN, the records and the tax. Knowing which side you are on matters, because the obligations follow the activity, not the label you would prefer.

GST is worth understanding rather than fearing, because it trips up new business owners. The goods and services tax is 10 percent, added to most sales, but the business does not keep it. It collects the tax from customers on the government's behalf and hands it on, while claiming back the GST it paid on its own purchases. So a registered business is really a temporary holder of that money, not an earner of it, which is exactly why treating collected GST as though it were profit is one of the fastest ways to a nasty bill when the quarterly return falls due.

Up to the ASX

Companies listed on the ASX play the same game with harder rules. They must publish audited financial reports every year, prepared to accounting standards, so the public can rely on them. An audit is an independent check of the books by an outside firm. When you eventually read a company report before buying shares, you are reading the same three statements the cafe owner reads, with more zeros and more scrutiny.

The reason the rules get heavier as businesses grow is that the number of strangers relying on the numbers grows with them. A sole trader's books mostly inform the sole trader. A listed company's reports inform thousands of shareholders, most of whom will never set foot in the place, so the law demands the reports follow common standards and pass an independent auditor's check. When the investing topic talks about reading a company before buying its shares, these audited statements are the paperwork it means, which is why learning to read the cafe's three reports is the same skill you will one day use on a company worth billions.

Software does the sorting, humans do the thinking

Almost no business does its books on paper anymore. Accounting software pulls in bank transactions, sorts them into categories and drafts the reports automatically. What software cannot do is decide what the numbers mean: whether to raise prices, drop a product or take a loan. The judgement is the part that stays human, which is good news for anyone learning it.