Accounting
is considered to be the business language used by all businesses. There are
many methods to perform accounting. The most common form of accounting is the
accrual basis, however many small businesses use a simplistic approach known as
the cash basis.
The
cash basis of accounting is a very simplified approach to accounting. It
revolves around the saying “cash in, cash out”. It is predominantly used by
small businesses ranging from mom and pop shops to small professional service
firms.
Cash
basis provides business owners, without an accounting background, to project
future income and expenses. It is considered an uncomplicated and easy way to
manage finances. But it doesn’t provide the most accurate projection and
snapshot of a company’s financial health.
On
the contrary, the accrual basis of accounting is a more complicated approach to
accounting. It provides an accurate snapshot of a company’s financial position
and financial health.
Below
is a simple formula on how to convert cash basis financial statements into the
accrual basis.
Operating Revenue:
Cash
Received from Customers
- Beginning Accounts/Notes
Receivable (This represents revenue earned last year)
+Ending Accounts/Notes
Receivable (This represents revenue earned this year)
+Beginning Unearned Revenue
(This represents revenue earned this year)
- Ending Unearned Revenue (This
represents revenue that will be earned next year)
Revenue under the Accrual Basis
In
order to calculate operating revenue under the accrual basis, first start with
all the cash received from customers. The next step involves reviewing the
invoices sent out to clients. Invoices sent out to customers represent accounts
receivables. The ending balance of the uncollected accounts receivable from the
prior year, are considered income recognized in the prior year. The ending
balance of the uncollected accounts receivable balance at the end of the
current year is considered income earned in the current year. The next step involves reviewing all income
received in advance. Unearned revenue represents revenue received before it is
earned. The beginning balance of the unearned revenue account for the current
year represents income earned in the current year. The ending balance of the
unearned revenue account for the current year represents revenue that will be
earned next year.
Operating Expenses:
Cash
Paid for Operating Expenses
+ Beginning Prepaid Expenses
(This represents expenses paid this year)
- Ending Prepaid Expenses (This
represents expenses that will be paid next year)
-Beginning Accrued Liabilities
(This represents expenses recognized last year)
+ Ending Accrued Liabilities
(This represents expenses that have not been paid for)
Expenses under the Accrual Basis
In
order to calculate the operating expenses under the accrual basis, first start
with all expenses paid in cash during the year. The next step involves all
expenses paid in advance, or otherwise referred to as prepaid expenses. The
beginning balance of prepaid expenses represents all expenses paid for this
year, while the ending balance represents expenses that will be paid next year.
The next step involves expenses that have been incurred but not yet paid for
during the current year. Those are referred to as accrued expenses. The
beginning balances of accrued expenses were recognized as expenses in the prior
year, and the ending balance of accrued expenses are recognized as expenses in
the current year.
Below is a sample spreadsheet that displays how to convert from the cash basis financial statements to accrual basis format.
Cash to Accrual Basis Spreadsheet Example
Cash to Accrual Basis Spreadsheet Example