In grade school, the concept of the leap year probably rocked your world. Every four years, there’s a year with an extra day? And what on earth happens to the kids whose birthdays fall on February 29? Do they live four times as long as the rest of us? Well, when you start a business or begin filing taxes, it’s also important to learn about other types of years, too. Much to the chagrin of those of us beginning the journey of financial literacy, there are important distinctions between the calendar year and fiscal year.
Differences between the Calendar and Fiscal year?
The calendar year is exactly what you learned in grade school: it starts on January 1st, lasts 365 days (or 366 in the case of a leap year), and ends on December 31st with the glitzy New York City ball drop.
The fiscal or financial year, however, is used to refer to a business’s accounting period. While a fiscal year has the same length as the calendar year, it may have different start and end dates.
The distinction between these two terms can get a little confusing because a fiscal year can (and often has) the exact same starting (January 1st) and ending (December 31st) dates as the calendar year. In fact, many businesses elect to follow the calendar year while others do not.
So, why in the world do some businesses decide to establish a fiscal year that is different from the calendar year?
What is the purpose of the Fiscal year?
After filing a 1128 IRS form, a business can justify a change in fiscal year. This is often done for organizational purposes. While following the calendar year like most businesses is usually the simplest possible route, if your company is seasonal in nature, it probably makes sense to establish starting and ending dates that reflect the flow of business.
For example, let’s say your tee shirt store has cornered the market on Festivus Day shirts. According to ancient tradition, this holiday is celebrated on December 23, so it might be expected that sales would pick up during that month as Festivus faithfuls purchase gifts for one another.
It’s not hard to imagine that closing out accounts according to the calendar year schedule (December 31st) just as business is booming for Festivus and other year end-holiday celebrations might put a strain on your business resources. Thus, for organizational reasons, many businesses elect to change the date they end their fiscal year.
So, while many companies may start their fiscal year on January 1st and close out their accounts on December 31st, it may make more sense for others to close out on May 31st and start on June 1st.
Permitting this flexibility for establishing a unique fiscal year allows companies to manage business flow, sales, and their resources better than a universal calendar year would. Plus, the fiscal year is an important tool for the comparison of financial performance.
As an investor, consumer, or competitor, you can learn more about companies and their growth by comparing their fiscal years. Even governments’ progress can be measured in terms of this time period to see how policies affect the economy over time.
How does a Fiscal year relate to quarters?
Fiscal years are broken down into three-month periods called quarters. The standard quarters are often abbreviated as Q1, Q2, Q3, and Q4. Quarters are used to describe company’s earnings reports, which usually contain details like net income, earnings per share, and executive changes.
Dividend payments also happen at the end of quarters. It’s important to note that, like the distinction between the calendar and fiscal year, some companies do not report according to the calendar year (called calendar quarters), but rather according to their own schedule (called fiscal quarters).
As you build your investment portfolio, understanding fiscal years, quarterly earnings reports and the dates for the end of each quarter will become increasingly important as you learn to balance and manage your investments.
Understanding these terms will help you to diagnose a given company’s financial health by comparing company performance and profitability over time, ultimately helping you to know if it is wise to invest or not. In other words, these terms are building blocks to help demystify the initially overwhelming world of investment.
Understanding the difference between a calendar and fiscal year is an important step in understanding how to file taxes, how businesses function financially, and how to manage your investment portfolio. While at first it might seem like a term referring to financial time travel, the fiscal year is actually a valuable tool for economic organization and comparison.