USA Cash vs. Accrual

[Mark55]

My partners and I own a small business and use the cash accounting method. Our 2014 taxes show a positive cash amount. I was explaining to someone that this did not mean we were a profitable company because our accrual profit and loss statement shows that we lost money in 2014 (and our revenues and expenses are properly entered into each month). It is my understanding that the positive cash number just meant we were well-collected on December 31, 2014.

My business partner adamantly disagrees with this and says we were absolutely a profitable company as long as our cash statements show a positive number at year end. He is saying that we are making money and I'm saying we are not.

Any input on this matter would be great as this is straining our relationship.

 

[kirby]

Assume you and partner both put $10,000 into the partnership bank account to start the business. Per your partner's theory you are "profitable" right now in spite of the fact you have not sold one thing because partner sees you have $20,000 in the account.
OK, next let's say you have that initial $20,000 and you LOSE $15,000 in bad deals. So , since your partner will see $5,000 in the bank account apparently they will say you are "making money."

I predict you are in for some rough times with a partner who thinks like this.

Good Luck!

 

[b03liberty]

Mark, next time i will advise you to replace cash system to accrual system. Accrual accounting is preferred to cash accounting even by the standard setters.
Though Individuals and some small companies do use cash-basis accounting. The cash basis is justified for small businesses because they often have few receivables and payable. Medium and large companies use accrual-basis accounting.

Under cash-basis accounting, companies record revenue when they receive cash. They record an expense when they pay out cash. The cash basis seems appealing due to its simplicity, but it often produces misleading financial statements. It fails to record revenue that a company has earned but for which it has not received the cash.
Also, it does not match expenses with earned revenues. Cash-basis accounting is not in accordance with International Financial Reporting Standards (IFRS).
Hope this help

 

[Pat A.]

Mark, there isnt enough info in your explanation to give an answer, but most likely your partner is correct. It is too complicated to explain why on this forum, I am better on the phone. If you are interested in speaking to a New York City Accountant who deals with this kind of situation regularly please email me your cell # at (e-mail address removed) and I will explain this for you.

 

[Bad Medicine]

My partners and I own a small business and use the cash accounting method. Our 2014 taxes show a positive cash amount. I was explaining to someone that this did not mean we were a profitable company because our accrual profit and loss statement shows that we lost money in 2014 (and our revenues and expenses are properly entered into each month). It is my understanding that the positive cash number just meant we were well-collected on December 31, 2014.

My business partner adamantly disagrees with this and says we were absolutely a profitable company as long as our cash statements show a positive number at year end. He is saying that we are making money and I'm saying we are not.

Any input on this matter would be great as this is straining our relationship.

Cash vs. Accrual - it's all about the reporting. The ONLY reason accrual is used instead of cash is because it makes your financials more "realistic". For example, in cash accounting if you pay your rent 10 years in advance for 50000$us then you have a 50000$us expense now, and no expense for the next 10 years - that does not accurately (or semi-accurately) reflect the reality of your situation. The alternative is accrual, where that 50000$us doesn't show up as an expense, instead it shows up on your books as a 50000$us asset which is "depleted" or used up over the course of 10 years, 5000$us/year, so every year 5000$us of this pre-paid rent asset becomes an expense. That's the goal of accural accounting, to try to more accurately show what is really happening in the business in a way that cash accounting cannot. That example was a prepaid expense, but same is done with accounts receivable, accounts payable, accrued taxes, depreciation, etc, it is all an "evening out" process to try to more accurately show what is going on in the business. Most companies switch to accrual because they have to, but the reason they "have to" is because whoever is making them do it (tax authority, investors, etc) wants a more accurate picture of what is going on in the business.

As for whether you're losing money - probably. Assets on the balance sheet (cash or accrual) are actually expenses in the sense that you spent cash to purchase them, so .. yeah, that's money out the door whether its an "asset" on the books or not. Having a computer that you paid 1000$us for isn't really any better than having paid 1000$us to watch strippers at a night club as far as cash flow in concerned.