To encourage clients to hire us we offered a 180-day financing option which allowed our larger customers six months before paying for the services they received. As we just completed our first year of operations this is what we found out regarding our financial stability.
We are currently reporting high sales; this is due to our 180-day financing to our larger customers. While this shows that the company is doing well on paper, we have experienced a low bank balance. Because the cash and accrual accounting methods differ, we were not keeping track of the actual flow of cash.
By offering the 180-day financing, we did not anticipate the effects that those sales will have on our cash flow or our ability to pay the cash on delivery obligations to our non-current equipment suppliers. Sales increased; however, we did not receive the cash. We need to find a balance that will suit our business needs for our company size.
Cash and accrual accounting differs due to the timing of when sales and purchases are recorded. Cash accounting recognize revenue and expenses when money is collected, which is not recognized as accounts receivable or accounts payable. The cash method is beneficial in tracking the amount of the company has on hand. Accrual accounting recognizes revenue when the sales and purchases made and services rendered. The benefit of accrual accounts it provides a realistic view of the income and expenses during a specific period. The disadvantage is it does not provide a view of the cash flow.
Accrual accounting maximizes the operational abilities by highlighting the revenue recognition and receivables throughout, increasing efficiency is an advantage, which, is why the Generally Accepted Account Practices (GAAP) requires accrual accounting when reporting sales. However, some circumstances prohibit companies from using the cash method and even require accrual accounting, although cash accounting is not accepted by GAAP reporting requirements, it is not limited to it.
The cash accounting method, transactions based on the company’s flow of cash as monies moves in and out of the company. Revenue recorded when the cash is received and the expenses are recorded when payments are made. The accounts receivable or accounts payables are not tracked on the balance sheet, by using the accrual method balance sheet will not include, or track, the accounts receivable or accounts payable they are recorded and tracked separately.
Larger companies are incline to view the financial information as insignificant when using the accrual accounting method, we are not that type of company, the cash accounting method is sufficient because of our size.
Let me reiterate if we incur a large expense that will allow the company to provide a service prior to receiving a payment for the service, the financial statements may convey an inaccurate or a distorted view of the financial condition of the business.
Substantial misrepresentation on the financial condition of a business is reflected on the financial statements if it has received a large payment but has not yet provided the service; cash accounting involves less effort in bookkeeping but it is not in accepted by the GAAP.
So how did we have a positive net income but a negative cash flow for the same year? We provide more services but received less money within the reporting period so while sales was increased cash flow decreased. To correct this issue we will record our business progress on the balance sheet which will compile the data we need to have a snap shot of our cash flows, the balance sheet will now be include three parts, the assets, liabilities and the equity. The assets will reflect what the company owns, liabilities will include the money we owe (payments that need to be paid,) and the equity will include what we have after our debts are paid. It will not include the accounts payable, receivable, or the inventory these items will need to kept track of and recorded separately.
As a small business, it is important for us to know how much cash we have on hand and record money as it enters and exit the business to have an accurate account of cash on hand. By having this snapshot will prevent overspending and plan for financing deals.
Understanding Cash Flow and Accounting Methods. (2023, Mar 09).
Retrieved December 10, 2024 , from
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