This week while we waited for our drinks at Starbucks, I told a small business owner friend about a couple tricky small business finance lessons. My point was “sole proprietor, beware.”
He was delighted to learn how sole proprietors can mislead themselves on their P&L (profit & loss statement – also known as an income statement) if they are reporting properly. Unlike other legal structures, a sole proprietor does not get a salary or wages so his income doesn’t show up on the P&L. He pays himself from Owners Equity, which shows up on the balance sheet.
Owner’s Equity Payments Don’t Show on Your P&L
When you do it correctly, you can think you have more money than you do because when you look at your P&L, it shows your “profit.” However, as a sole proprietor, you take your money out of Owner’s Equity.
I had a client, “Marvin,” (name is changed for his privacy) who was panicked about paying his employees after he paid our invoice. I didn’t understand Marvin’s concern because per his P&L, he had a couple hundred thousand dollars in profit.
His worries alerted me to a problem. After I dug into his financial information as best I could (not all of it was reported correctly), I realized that neither he nor I had looked at his balance sheet. It was then that I learned he was taking $60,000 out as his personal income so it didn’t show up on the P&L. That combined with a few other issues that came to light showed that he was “in the hole,” not profitable as I originally thought. (There were other issues that contributed to his owing more than he was making.)
By the way, if you are a coach, consultant, freelance writer or just have a solopreneur type business even without a physical structure or store front, you are probably a sole proprietor.
Like Marvin, if you are a sole proprietor who thinks that your profit is at the “bottom line” of your P&L, you may be surprised your checking account doesn’t show the same amount as your “net profit.” This isn’t a problem once you know about it and just have a basic understanding of what to look for on your financial reports, i.e. both the income statement and balance sheet.
This article is about managing your small business finances. It’s for your information only, neither for legal nor for financial advice. Please check with your accountant or attorney for advice specific to your business.
Building your profits through strong relationships,
John R. Aberle, Aberle Enterprises
For more information about being a sole proprietor, check out what the SBA (U.S. Government’s Small Business Administration) has to say about sole proprietorship.