Practical Lesson In Financial Accounting
If you are a small business under 10M in sales revenue, you have the option of either using cash-based or accrual-based accounting. And if you’re in a business that has a high percent of Account Receivables, you’re better off using cash-based accounting. Why? Because you’re paying taxes upfront on income you won’t be receiving for another 90-120 days (depending on the payment terms you’re offering your customer).
My friend Vijyendra is a wholesale importer of stones from India. It is a very high-margin, but slow-growth business. He has been in business for about 3 years and is currently importing 1 container a month, half of which is pre-ordered stones. When he puts an order in for a container, he has pay his supplier within 30 days. However, he doesn’t get paid from his retailer till the stone has been etched and shipped to the end customer (90-120 days). To make matters worse, December is the busiest month (yes, among other good stuff people also buy and upgrade tombstones when they get their annual bonuses). So when it is time to close the books, he is showing zero payables and 25% receivables. Not good if your books are Accrual-based!
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