Cash basis or accrual: which set your funder is actually reading

Two profit figures for the same twelve months, both correct, tens of thousands of dollars apart. That is not an accounting trick; it is what the two bases measure. Cash basis records revenue when money arrives and cost when money leaves. Accrual records revenue when you earn it and cost when you incur it, regardless of when either settles.

For a business that gets paid on the spot and pays its suppliers on the spot, the two are nearly identical and the choice barely matters. For anything that invoices on terms, carries inventory, or takes deposits for work not yet done, the gap is large and it moves in a direction that depends on whether you are growing.

The arithmetic, on one year

• Accrual profit: 1,240,000 − 806,000 − 298,000 = 136,000
• Cash-basis profit: 1,144,000 − 748,000 − 298,000 = 98,000

The 38,000 difference is exactly the growth in receivables (96,000) less the growth in payables (58,000). Nothing was hidden. The business simply financed 38,000 of net working capital during the year and the cash statement charges that against profit while the accrual statement does not.

Now put debt service against it. Say the monthly debt service is 5,900, so 70,800 for the year, and depreciation is 41,000.

• Accrual coverage: (136,000 + 41,000) / 70,800 = 2.50
• Cash-basis coverage: (98,000 + 41,000) / 70,800 = 1.96

Both are respectable here. Shrink the margin and the same gap decides the file. A business with 60,000 of accrual profit and a 38,000 working-capital swing shows 22,000 on a cash basis, and a coverage ratio that was comfortably above one falls below it.

Note the direction. A growing business on terms looks better on accrual. A shrinking one looks better on cash, because collections from last year's larger receivable book arrive in a year with smaller sales. Accountants know this. So do underwriters, which is why the basis is one of the first things they check.

Who reads which

The trap: converting for the application

The temptation, once you see the numbers above, is to produce accrual statements for the lender while filing on cash. Two things go wrong.

The tax return and the financial statements no longer agree, and the return is the document you did not write, so it wins. An analyst who sees 1,240,000 on your P&L and 1,144,000 on your return will ask you to bridge the difference. The bridge exists and is legitimate — it is the receivable movement — but you have to be able to show it on one page with the ageing report behind it. If you cannot, the file stalls on the suspicion that revenue was inflated.

The second problem is that a conversion done for one period is almost always done badly. Accrual is not a switch. It requires an opening receivable and payable balance, consistent treatment of inventory, deferred revenue for anything prepaid, and the same treatment applied to the comparative period. Converting only the current year produces a comparison of an accrual year against a cash year, which is meaningless and visibly so.

The decision procedure

1. What basis do you file on? If accrual, run accrual books and stop reading. The choice is already made.
2. Do you invoice on terms, hold inventory, or take deposits? If none of those, stay on cash. Accrual adds work and changes nothing material.
3. If yes to any, what product are you going for? Bank term debt, a real line of credit, SBA or an asset-based facility: convert to accrual properly, with an opening balance sheet and a restated comparative, and do it at a year end rather than mid-year. Revenue-based or bank-statement products: do not bother.
4. Are you growing or shrinking? If shrinking, understand that accrual will show the decline earlier and more sharply. That is not a reason to avoid it, but it is a reason to have the explanation written before the question arrives.
5. Can you produce both? A cash-basis business that maintains a receivable and payable ageing can produce an accrual bridge on request without restating anything. That is the cheapest position: file on cash, keep the ageings current, and hand over a one-page bridge when someone asks.

What to have ready

Whichever basis you use, label it on the face of every statement — entity name, statement type, basis, exact period, date produced. An unlabelled P&L invites the question and the answer is worse when it comes from an analyst's assumption than from your header.

Then keep the bridge on file: opening and closing receivables, opening and closing payables, and the resulting difference between the two profit figures. One page. It converts an awkward discrepancy into evidence that you know your own numbers, and it is the difference between a stipulation that takes a phone call and one that takes a week.