Cash Or Accrual Accounting – Which Is Better For Business Owners?
Consider this :
Your Accountant just reported a good Profit to you for the month just ended, but your company Bank account showed a decline in Cash after 1 month in business operation.
What should you do as a Business Owner?
Should you be happy or sad as a Business Owner?
You must be pondering if you should be doing your Accounting on “Cash” or “Accrual” basis.
Cash accounting is an accounting method where receipts are recorded during the period they are received, and expenses are recorded in the period in which they are actually paid.
Accrual Accounting is where revenue and expenses are recorded when they are incurred.
Generally Accepted Accounting Principles (GAAP) requires all accounting books to be maintained on “Accrual” basis.
The correct answer is, as a Business Owner, you must let your Accountant do his bookkeeping using Accrual basis as per GAAP.
However, you must insist that your Accountant show you a monthly Cash Flow Statement with the following 6 categories of Cash Inflow and/or Outflows before arriving at NET Cash Generated for the month :
1. Cash from Operations (i.e. Profits from Operation, Movements in Working Capital, GST collections and payments on behalf). Please note Depreciation is excluded
2. Income Tax payment
3. Loans drawdown and repayment, plus Loan Interest Payments (i.e. P and I)
4. Purchases and Disposals of Capital Asset items (i.e. Capex)
5. Investments (in financial assets or in a company or property)
6. Share Capital Injections or Dividends
As a Business Owner, once you have a clear view of how exactly your Cash moved during the month in your bank account, you will know exactly how to make more sensible business decisions forward.
Take a look at this simple example :
If your Cash generated from Operations (category # 1) for the month was only $10,000.
Assuming that all the other categories in your Cash Flow Statement are showing Nil movement except for Category # 3 Bank Loan repayment of $15,000, this Business Owner would know that the cash generated from operations is not sufficient to pay for bank loan repayment, a typical state when a company is overly geared (i.e. Over borrowed).
The immediate decision of this Business Owner would be to increase the Sales and Profits of the business further in future months, and will not be contented with just $10,000 of cash profits generated from his operation.
Hence, a higher Sales Target / KPI will need to be set for future months.
Hope the above simple pro-tip helps.
If you need help, feel free to contact us at :
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www.corporatebackoffice.com.sg
