What does this really mean and how does each affect your business?  There are businesses that cash basis accounting is for the most part what the business model is.  One could look at owning a bar, having a hairstyling salon, coffee shop, real estate business and see that cash comes in and is expensed mostly during the month that revenue is earned.

 

Let’s take a closer look at the humble bar for example.  Customers come in and purchase a beverage and or food, thus revenue is coming in that day (cash earned).  Fresh food ingredients have a short shelf life and generally will be consumed within the week purchased (current month).  However, frozen food can be carried over into the following month.  Then, how often is the alcohol being turned over?  Does the bar place a monthly (current month) order or does the owner purchase enough supply for two to three months to get a discount?  Once inventory is being carried over into another month and being paid in a prior month, expenses no longer match current revenues earned, thus there will be an inconsistency in “cash basis” with Cost of Goods Sold (COGS) and Gross Margin (GM), where Gross Margin is Revenue – COGS.  Once one starts carrying inventory into another month, gross margin will fluctuate, and accrual accounting should be used to match actual expense (alcohol used) with monthly revenue or cash received in this case.

 

Why does this matter? Planning (budgeting), understanding what ones actual COGS to Revenue allows one to budget monthly and weekly, and when one is looking to grow the business understanding Gross Margin is extremely important.  The higher the GM, the more cash you have to work with for Sales, General, and Administrative costs which if used correctly will expand one’s business.