The Simple Heart of Finance
Wait what? Finance can be simple?!
Yes! It can be! I mean... it can at least be a whole lot simpler than most people make it seem.
Finance can be overwhelming and complex, but at its heart it’s actually very simple - if you understand all of finance is really about answering one simple question. And if you understand what that simple question is, your practice P&L will start making a lot more sense.
If you’d like to make more empowering financial decisions in your private practice and personal life, then today’s video is for you.
I love reading... 😍📚
And yet, I think this video 📹 will be a whole lot easier to understand. 👇
(I've included all kinds of fun slides! Ok, they're not THAT fun. But still.)
Did you miss the video? It's right there 👆
Still keen to read?! No worries... here we go!
Alright, so I have great news! Finance is actually very simple. I know, it doesn’t seem that way, but EVERYTHING in the financial world comes back to a single, simple question. And everything in the financial world is either trying to better answer that question or improve the answer to that question.
Alright, so here it is… all finance does is look at... how much money is coming in… subtracts how much money is going out… and that tells you whether you have a surplus or deficit. That’s it. That’s all finance is ever about: is there more money coming in or going out? If you have $100 coming in and $50 going out, you have a $50 surplus. Congrats! If you have $100 coming in and $150 going out, you have a $50 deficit.
So what is this simple equation really? Well, it goes by a number of different names. It’s the Profit & Loss statement, also known as the Income Statement. We could also think of this as a cash flow statement. For now, let’s just call it the Profit & Loss statement (or P&L) since that’s easy to say.
So if we think about this P&L as encompassing your entire life, that’s pretty simple. We’re simply looking at all the money you have coming into your life, from any source (including your private practice) and then looking at all the money flowing out of your life, for whatever reason or purpose.
And while that’s pretty simple, it’s not super useful because it has everything from every source and every time period all mixed together. It’s pretty much impossible to make heads or tails of what’s happening. And so to make the P&L more useful, we begin to segment, categorize or split it up in different ways.
One obvious way to split, or segment, the P&L is to create two different statements, one for your private practice and one for your personal life.
Another way we split the P&L up is by segmenting different time periods, so we can see what’s happening each year for instance.
And then we could further divide a year into different quarters… and we could divide those quarters into months, and then…. Well, you get the idea.
Again, the reason we’re splitting or segmenting the P&L is to make it more understandable. If I have more money going out then coming in, I need to change something. By looking at a reasonably small time period, I can more easily see where (and when) I’m spending more money than I intend.
So if I notice that, say, in the month of December, I have a lot of money flowing out of my business, I need to look a bit deeper to understand what exactly is happening.
And that brings us to the other way we can expand the P&L, which is to expand what we’ll call the line items. I think of this as a vertical expansion, whereas expanding the P&L over different time periods is a horizontal expansion.
So, what am I talking about with this vertical expansion of the line items?
Well let’s go back to our core equation, and see how we would modify and expand the line items if we were looking at the P&L of your private practice.
For starters, the money coming into your business, let’s call that revenue. There are a few other names you might hear that are synonymous with revenue such as sales, gross income or gross receipts. But let’s stick with revenue because I think it’s the least ambiguous term.
Alright, so the top-line of our P&L is revenue. That represents all the different ways money flows into your business. In your private practice, the primary revenue will likely be from clients paying your session rate.
And what about the money going out? Well, we can break that down into two big buckets: business expenses and taxes.
Alright, so let’s move on to a clean sheet here. So again, our top line is revenue. From revenue we’ll subtract all the business expenses that you incur. So whatever costs you have to run your business like, rent, licensing fees, software, advertising costs, whatever expenses you incur to keep your practice up and running, we’re going to deduct those here.
What’s left over after we subtract all those expenses are your earnings before taxes. Then, of course, we have to subtract taxes and that leaves you with Net Income. Net Income is the amount of money that flows out of your business to you.
Let’s return to that Business Expenses line item for a moment. You will sometimes hear business expenses described as deductions or write-offs. These terms are used primarily to highlight the fact that these expenses reduce the amount you owe in income taxes. Why is that? Well, because these expenses, deductions or write-offs reduce your Earnings Before Taxes. And Earnings Before Taxes is the amount on which your income tax is based. The higher your earnings before taxes, the higher your income tax will be.
Alright, so before we wrap up, allow me to go on a brief tirade against the word income. I just want to urge you to be careful when using or seeing the word “income”, because I think it’s a really ambiguous term.
Are we talking about: gross income, income before taxes, net income… it honestly isn’t clear. And you will run into the word income all over the place. I’ve even seen it used in QuickBooks in a way that I found really perplexing.
So anytime you see the word income without a descriptive adjective in front of it, take a moment to clarify what is meant. This is a great time to mention one of the best financial questions you can ask when working with finances, is ‘what do you mean’. I also love it when people tell me they don’t understand. Never be shy about pushing for clarity and additional explanation. Ok, anyway enough of that.
That's a Wrap 🎬
Alright, that’s it for today! I hope this has begun to demystify the world of finance a bit for you and helped you understand a bit better the P&L of your private practice.
I’d love to hear how I can improve content like this. What made sense? What was unclear? What else would you like to hear about that would be helpful? Give me a shout and lemme know!
Looking for more great resources to help you navigate your financial life? Check out my free Guide to Financial Planning for Therapists. Click here to access!
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes financial, legal or tax advice; a recommendation for purchase or sale of any security; or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Read the full Disclaimer here.