WorkWiz

Do you know the difference between CASH based accounting, and ACCRUAL based accounting?

These 2 reporting methods can result in wildly different figures

Let’s start with some definitions…

➡️ The CASH Basis

Under the Cash basis of accounting, money IN is treated as income, while money OUT is treated as expenses

Note that while this is generally true, there are some exceptions:

☝️ Money IN can represent an expense refund (negative expense), or debt (which is a balance sheet item) to name a few…

✌️ Money OUT can represent a sales refund (reduction in sales), or inventory / fixed asset (which are balance sheet items) to name a few…

➡️ The ACCRUAL Basis

Under the Accrual basis of accounting, income is only recognized once it’s EARNED, while expenses are only recorded once they are INCURRED

And this is where so many of the adjusting journal entries that are required each month are prepared such as

1️⃣ Prepaid - causing you to amortize certain expenses paid upfront to be split over the the period in which it gets incurred

2️⃣ Deferred Revenue - causing you to amortize income collected / invoiced upfront over the life of the contract

3️⃣ Accruals - causing you to recognize certain expenses in the current period, even if the bill hasn’t been received, or the payment has been made

These are just a tiny few of the many adjusting journal entries required for a month end close

🤔 So which method do I prefer?

Well…that depends a lot on the company

For small companies, the cash basis is great, as it simplifies much of your reporting

At the same time, larger companies almost always opt for the accrual basis of accounting, for the following reasons

1️⃣ GAAP Requires Accrual

While the IRS may allow companies up to a certain size to report under either method, GAAP requires you to reconcile under the accrual method.

That can be especially relevant for the 2nd reason:

2️⃣ Investors like to see what’s really happening

When you have outside investors, it’s common for them to want to see your financial statements under the accrual basis

Why?

Because the accrual basis explains what’s really happening in the business

So in short:

◾ SMALL BUSINESSES without a heavy amount of outside capital can benefit from the SIMPLICITY of the CASH BASIS of accounting

◾ LARGER BUSINESSES with a larger amount of outside capital are often required to record under the ACCRUAL basis

That’s my take on the Cash vs Accrual basis of accounting…but there’s much more to it

What would you add?

Let me know by joining the discussion in the comments below 👇


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Learn about 3 Financial Statements 📄 📄 📄

It doesn’t matter what field you’re in… if you understand how Financial Statements work..

you understand a lot about BUSINESS. This can add tremendous value to ANY profession…

Whether you’re a doctor 👩⚕️…

engineer 👷…

or CEO 👔

Let’s do a deep dive into each:

📄 𝐈𝐍𝐂𝐎𝐌𝐄 𝐒𝐓𝐀𝐓𝐄𝐌𝐄𝐍𝐓 (also known as Profit & Loss)

This represents everything in terms of what your company is EARNING...

as well as what your company is SPENDING It in essence tells you about the Profits & Losses of your business (hence the name)

Here are the major sections (and what they mean):

⚫ REVENUE

What is being earned via sales

⚫ COGS

The cost to deliver your product or service

⚫ GROSS PROFIT

Your profitability in carrying out your product or service (Revenue - COGS)

⚫ OPERATING EXPENSES

All other costs that relate to your core business, but aren't necessary to carry out your product or service (IE not COGS)

⚫ NET OPERATING INCOME

Gross Profit less Operating Expenses

⚫ OTHER INCOME

Money earned that is not core to the business (common ones can be interest income, or cash back from credit cards)

⚫ OTHER EXPENSES

Expenses that are incurred that are not core to the business (common ones can be depreciation and interest expense)

⚫ NET OTHER INCOME

Other Income - Other Expenses

⚫ NET INCOME

Net operating income + Net other income

📄 𝐁𝐀𝐋𝐀𝐍𝐂𝐄 𝐒𝐇𝐄𝐄𝐓

Here you can see a snapshot of everything the company OWNS (assets)...

while also understanding what the company OWES to creditors (liabilities)...

and the money put into the business through investments & prior profits (owners equity)

It is separated by 3 sections:

⚫ ASSETS

What the company owns / substantially controls that represents economic value. Common ones are cash, accounts receivable, and prepaid expenses

⚫ LIABILITIES

What the company owes to creditors. Examples can include credit card balances, accounts payable, and deferred revenue

⚫ EQUITY

This is the net value of the company that the owner's can claim, and is typically comprised of amounts invested, and prior earnings (retained earnings)

📄 𝐒𝐓𝐀𝐓𝐄𝐌𝐄𝐍𝐓 𝐎𝐅 𝐂𝐀𝐒𝐇 𝐅𝐋𝐎𝐖𝐒

This statement shows you all of the details that makes up the movements in your cash balance on the balance sheet.

It is comprised of 3 sections

⚫ CASH FROM OPERATING ACTIVITIES

This section shows all of the cash flows from activities related to operating the business

⚫ CASH FROM INVESTING ACTIVITIES

Here you show the cash movements from long term assets

⚫ CASH FROM FINANCING ACTIVITIES

Here you show the cash from all equity investments and debt injected / paid out from the company

This summary is just a brief overview of these 3 statements - what would you add to the topic?

Let us know by joining the conversation in the comments below 👇

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Day 01:
➡️ ACCOUNTING FUNDAMENTALS

The Accounting Equation

Often times the first thing you’ll learn in a college Accounting course…

and many would say it’s the most important concept in Accounting (hence the name)

But what’s so special about it?

Let’s dive in.

➡️ What the idea?

This equation summarizes how a business can be interpreted using a report called a “Balance Sheet”.

It introduces the concept of “double entry” accounting, where every transaction in a business affects 2 items in a balance sheet, and atleast 1 of these section.

➡️ What exactly does it mean?

Let’s do a quick set of definitions…

Assets → Items of economic value that the business owns or substantially controls (cash, receivables, inventory)

Liabilities → amounts that you owe to creditors (credit cards, loans, deferred revenue)

Owners Equity → amounts that the owners are owed (IE: what’s left after you subtract liabilities from assets)

So the accounting equation explains that all of your assets came from either amounts funded by creditors (liabilities) or owners (owners equity)

➡️ What’s so special about that?

Well…a lot.

1️⃣ It all balances

Net Income is calculated on your P&L by taking all income accounts less all expense accounts...

and that feeds into your owners equity via an account called retained earnings.

So when net income goes up, your owners equity goes up…

when net income goes down…your owners equity goes down.

Since Assets must always = liabilities + owners equity, you know that the must be a corresponding effect in your assets or liabilities.

2️⃣ Debits & Credits

Debits & Credits are the mechanism you use to showcase the movements of account balances in your general ledger.

So however they work for Assets, is the complete opposite for how they work for Liabilities and Owners Equity.

ex:

Assets: ⬆️ Go up with a Debit, ⬇️ Go down with a credit

Liabilities + Owners Equity: ⬆️ Go up with a credit, ⬇️Go down with a debit

Now you know your debits & credits

3️⃣ Cash flows

If you understand the accounting equation, you can prepare a statement of cash flows under the indirect method

See…Assets = Liabilities + Owners equity

Which means the net change of Assets from one period to another…

is equal to the net change of Liabilities + Owners equity from one period to another.

So if we flip the calculation on one side of the equation, and add up the net change in all accounts, we’ll get to 0.

Like this:

Last months Assets - This Months Assets
+
This Months Liabilities - Last months Liabilities
+
This months owners equity - last months owners equity
= 0

Great! So if we do that now for all accounts EXCEPT for cash…that becomes our plug for how much our cash went up or down

Now you know how to create a statement of cash flows

===

Got anything to add? Let us know in the comments below 👇

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Before 19th July 2021