Q: I have been running the numbers on the profit-and-loss (P&L) statement for a new business venture and at the same time computing return on investment. In the process, the following question came up: If I take out a loan for startup capital, is it correct to include those loan payments as part of my expenses?
--A.B., Manila

A: Few questions in accounting are simple, which is why entrepreneurs are usually advised to hire a certified public accountant familiar with small-business needs rather than try to do the number-crunching themselves. It's almost impossible to give a universal answer to accounting questions, since each country has a set of "generally accepted accounting principles" that its CPAs are expected to follow and its own tax laws, which affect how things are accounted for and even business strategies, such as mergers, acquisitions, and corporate structure. As the rules in the Philippines may vary from those in the U.S. as set forth by the American Institute of Certified Public Accountants, you'll need to consult with a local practitioner. That said, here's a rundown on some basic principles.

When you start a business, you or your bookkeeper should draw up financial documents, including a P&L statement, a statement of cash flow, and a balance sheet. Put simply, the P&L shows the operating performance of the business: how much money the company is making and how much it costs to keep the company running. The balance sheet shows the company's position in terms of assets and liabilities at any point in time. The statement of cash flow shows where the company's cash is going -- into stock, equipment, rental deposits, or elsewhere.

Now let's look at how you account for a loan on those statements. With a conventional bank loan, you'll pay back both principal and interest over time. Each is handled somewhat differently on your books. First, your payments come out of cash flow your company generates and should be listed on your cash-flow statement. Next, let's take the interest component: In the U.S., says Barry Garfield, CPA and partner in the Melville (N.Y.) accounting firm of Holtz Rubenstein & Co., "the interest portion of the payment is [tax-]deductible and would be expensed in the profit-and-loss statement." The loan principal gets recorded as a liability on your balance sheet, while the funds that you received are initially recorded as an asset -- cash on hand, which diminishes as you spend it. How that's accounted for depends on what you use the money for. Meanwhile, as you pay down the debt, you reduce your liability correspondingly.

Calculating the return on your investment in the business is another matter. The way to compare investment opportunities is to project the internal rate of return -- the rate of interest at which the net present value (the value today) of the payments from an investment over a certain period equals the cost of that investment. Compare that to the rate of return investors require -- the hurdle rate -- for a given level of risk. If your business can give investors a higher rate, they'll bite.

"Your aftertax net income, plus depreciation, is the figure that you use to calculate your internal rate of return," says Paul Ratoff, a Los Angeles business consultant with the accounting firm of Moss Adams LLP.

You want to be conservative when projecting return on investment, experts say, so that your investors will be pleasantly surprised if their investment starts paying off more quickly than expected, rather than disappointed that the returns are not what you promised. You also must figure in cushions for the unexpected, like bad weather or fickle consumer demand. Say your merchandise sells wonderfully the first year but goes out of fashion the next. Instead of the rosy financial picture you had planned, you might be left with shelves full of unsold inventory that you'll have to discount.

If you're absolutely determined to do it yourself, there are plenty of books about accounting -- at all levels of difficulty. Alternatively, you might try contacting a local business school and asking if their accounting students set up books for small businesses as part of their coursework -- under the supervision of a qualified instructor, of course.

By the time your business gets going, you'll need an accountant to help you with your tax preparation anyway, and if you're going to approach a bank for a loan, the bank's managers will probably give you a list of accountants they have worked with. Here's another idea: Barry Garfield's firm is a member of an international group of accounting firms, DFK International, that includes affiliates in close to 80 countries around the world -- and its directory includes the Philippines.

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