Many service businesses use “cash basis” financial statements to file their income tax returns and in general, defer income tax in doing so. However, when it comes to managing their business, every business should look at BOTH cash based, and accrual based income statements because they both tell an important but different story.
Cash basis income statements are what I refer to as the “check book” income statements because with few exceptions it represents actual cash inflows and outflows during the period. That is, it represents the deposits to the bank, and the checks written during the period. This statement represents a “checkbook reality” statement which all business managers have to deal with (i.e. the actual cash in the bank).
Accrual basis income statements are what I call the “legal basis” income statements because they represent the actual completed sales during the period and the actual incurred expenses during the period. Not all of the completed sales (i.e. invoiced sales) will be collected during the period, and not all the incurred expenses (i.e. invoices received) will have been paid during the period, but the business manager will want to understand if the income generated exceeded the expenses incurred (i.e. Are you winning or losing the game).
For those who account for their business on QuickBooks, they can look at either statements on a cash basis or statements on an accrual basis by merely toggling a software switch. To do that in QuickBooks; bring up a profit and loss statement screen, select the “Modify Report” tab (left most tab), and then select “accrual” or “cash” on the report basis section of the screen that appears.
By using both statements (cash and accrual) you will be getting critical information about your business from two different by equally important perspectives.
Good luck and here’s hoping it “all adds up” for you.
(If there is any area in accounting or tax that you think needs to be addressed in this newsletter please e-mail Dick at Ginnatycpa@aol.com and if it is of general interest, he will address it in future articles)