By Michael Noel, MBA | September 21, 2017
Running a business is great…if the cash comes in and goes out in the right order. The purpose of business accounting is to help you sort this out in the most efficient, if not the easiest way.
Well, the easiest way is cash accounting – often done by balancing the business checkbook. Unfortunately, the simple story can leave out some important details.
“Why did the chicken cross the road?”
“That’s where he parked his car.”
Obviously, we missed part of the story. Cash accounting may suggest you made money, but that could be because the bills haven’t arrived yet, we haven’t paid all the bills yet, or we have sold all our inventory. With accrual accounting, costs are matched to revenue so you can determine if your business was profitable over a specific period of time.
If our billing and collection time frames change, accrual accounting can help us identify the issue and point us in the right direction to make changes as needed. This can help avoid “cash crunches.”
What if you paid every bill the moment it was due; and, you were paid the moment your product sold? This would be ideal for cash accounting.
So, this month you manufacture 1,000 doohickeys, the deluxe ones, at a cost of $2 each. That’s $1 labor and $1 material. It takes 30 days to make a quality doohickey of course, and you pay your employees every two weeks. You take delivery of materials and promise to pay your supplier on delivery. As everyone knows, doohickey sales are seasonal, so you produce a different number each month, but your material supplier only sells in bulks that give you a discount if you buy the same quantity monthly. You sell your doohickeys to your distributor for $4 each when they are complete. He sells doohickeys once a month and promises to pay you within 60 days of delivery.
This ebb and flow of cash makes it difficult to know exactly where one stands with the actual health of the business. At one point the checking account could look great, and at the next moment, well, not so good.
Now may be the time for accrual accounting! Accrual will allow you to understand your cash flow – and your real profitability throughout the year.
Accounting, unless you are an accounting firm, is probably not why you got into business; but good accounting is crucial to the management and success of your business. Consider how well your business would operate if there were no lights in your office or facility. You might make a few doohickeys, slowly with questionable quality in the dark; but, infinitely better in the light.
Accrual accounting can shine light on your business management and processes and greatly improve your odds for reaching your business goals.