If you want to get a handle on the numbers in your Construction Contracting business then it is imperative you understand your financial statements.
Understanding the difference between a cash basis financial statement and an accrual basis financial statement is a good start. Then, understanding what makes them different in QuickBooks online and how they’re deciphered there aids you in getting a firm grip on those numbers.
Cash Basis Perspective Gained – The Cash Flow within Your Construction Contracting Business
In its most simple format, Cash Basis is achieved by recording your income and expenses when payments are received and when expenses are paid. If money moves one way or the other it is recorded then and there. Your customer pays his invoice and the amount is entered as received. You buy some new tools and the cost is entered as paid out.
Example: Customer ABC agrees to a job which will cost him $1,000. He pays you when the job is complete. This is a cash basis transaction. (Even if he pays you with a credit card, it is a cash basis transaction because the credit card company will place the fund in your account within a couple of days.) Therefore, payment was made. Yet, if the customer pays you the next month, you won’t recognize the sale until next month.
Accrual Basis Perspective Gained – The Financial Health of Your Construction Contracting Business
Now, on to Accrual Basis. In this format, you record your income and expenses as payments are earned and expenses are incurred. Put simply, you record the transactions whether the money moved or not. What you’re doing is recording when the promise of payment is made, whether by you or by your customer. What you will see is either an Accounts Receivable or Accounts Payable in your books.
Example: You perform a job for customer XYZ. Once you’re done, you leave the job site. When you return to your office you generate an invoice and send it to her for $1,000. This is an accrual basis transaction. The customer now owes you money for your services and you now have an accounts receivable balance on your books.
Now if your construction business delivers long-term contracts, transactions that will take longer than 12 months or cross fiscal years, then these rules get a little more sticky. I won’t try to get into the ramifications of those circumstances in this post.
What all this means for your transactions through QuickBooks Online
In QuickBooks online, it is very easy to switch between cash and accrual systems in the reports. At the top of the report, where the options are listed, you will see Accounting Method. When you switch from accrual to cash, QuickBooks reverses out receivable and payable transactions because cash did not change hands, no cash moved.
Once you make the switch the financial statements will look different. And, as you can see, this is because some transactions are handled differently under each accounting system.
Not all transactions are converted equally under each system. Understanding these differences and how they affect your financials will help you understand which financial picture you are looking at.
One step further
Let’s go back to our previous example under the accrual method above, where you created the invoice for $1,000. This invoice will appear on your accrual basis Profit and Loss under sales but it will not appear on your cash basis Profit and Loss. Because of this difference, when you look at the cash basis Profit and Loss, it will not show you how many sales you really transacted during that period and your statement will be understated. Only the accrual Profit and Loss will show you the true sales number.
If customer XYZ pays you $500 of the balance, when you look at your accrual basis Profit and Loss under sales you will still see the $1,000 sale, but now when you look at your cash basis Profit and Loss you will see the $500 under sales. You only see the $500 because you actually received the cash.
Yet, when you look at this financial statement, your sales are again understated. This time by the $500 balance that remains. This is an important distinction to understand when looking at how much sales your business generated for the period.
The effect of these two examples can also occur in your expenses or accounts payable transactions. If you record a bill for $100 in supplies, that bill will appear in your accrual system profit and loss but not your cash system profit and loss. This will result in understated cash basis financials. Once you make a $50 payment on that bill, the $50 payment will appear on your cash basis Profit and Loss but that statement will still be understated by the $50 balance still due.
Know what you’re looking at
When looking through your financial reports, be certain you understand the type of data each report provides based on the accounting method being used.
We, at Schulte and Schulte, LLC believe the accrual method is best because it tells you the financial health of your business. Yet, if you are inclined to run a cash basis statement, be certain you understand what you are looking at and the story that it tells.
Have questions? Give us a call, we can even help you make sense of those long-term contracts and accounting that occurs cross fiscal years. 480-442-4032 or Toll Free: 866-629-7735