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Financial Forecasting 101

Financial Forecasting 101

If you’re a business owner or been thinking about opening up a new venture, the thought of improving its performance must have crossed your mind. And that’s where financial forecasting comes into play. 

It’s simply the process of looking into the future of your business based on historical data and trends. In this post, you’re going to learn the basics of financial forecasting and how it can help you.  

What is Financial Forecasting?

The definition is literally in the name. Financial forecasting is forecasting a business’s financial status. 

More specifically, this is the processing, predicting, and estimating the future performance of a business based on current data at hand. Company revenue is used as the benchmark in most basic cases. 

The sales figure can say a lot more than how much profit your business made. Those data sheets are effectively a portal to your business’s future. But it takes a different set of capable eyes to capture the essence. 

Apart from the current sales figures, historical data is also used in financial forecasting. It helps analyze the performance with regards to the past, present, and hopefully a better future. This method is widely used by successful CEOs and entrepreneurs around the world for its accuracy. 

Why is Financial Forecasting Important?

Any business with long-term objectives can definitely benefit from this process. It also helps to set new standards for the business as well as guide the decision-making process. 

Another very important reason why entrepreneurs use this process is to convince investors. 

Suppose, you own a winery and you wish to expand across different states. You know it will be a successful venture. But how do you attract more investors? 

That’s where financial forecasting comes to play. You can accurately determine the future of your winery by considering all the variables in your current model and projecting them into a future scenario. 

CEOs love this model because it can bring important insights such as how to spend business resources, what the industry holds for the future, how long the debts will hover over the business, how to pay the shareholders, etc. to light. 

And when you have at least an idea of what you’re diving into, making the right decisions at the right time becomes a lot less burdening to your shoulders. 

Types of Financial Forecasting

When venturing into the dynamic world of forecasting, you should know about the types as well. There are two major branches of forecasts. One is Qualitative while the other one is Quantitative. 

Qualitative Forecasts 

Qualitative financial forecasting does not rely on computers to analyze large data sets. It’s quite an unorthodox way of finding out the connection between events. Rather than following the sales figures, Qualitative Forecasts focus on decisions taken from experience and intuition. 

It starts with gathering opinions from major positions in each department. Analyzing their insights might be crucial for forecasting.

The next step might be taking a similar scenario from a different environment and projecting it onto the subject scenario. 

The Delphi Method is another important aspect of financial forecasting. It indicates that company professionals fill out a questionnaire. Based on it, another questionnaire is created and filled. Now, these are combined and presented to the participants to re-evaluate their answers. 

Scenario forecasting is another great method. The person tasked with the forecasting will project different results based on the consequence of scenarios. Your management team has the freedom to select any result you want. 

Quantitative Forecasts 

Unlike qualitative forecasts, quantitative financial forecasts solely depend on large historical data sets. These are used to find patterns and trends in the business space. These forecasts are more accurate in sectors where numbers speak louder than legacy. 

Pro-Forma Financial Statements is a great method used in this forecast where the sales data from the previous years are used to make the prediction. 

Another method is Time Series Analysis. For short-term goals and objectives, this the perfect method to use. It involves collecting data for a certain period and analyze it to find trends. 

Lastly, the Cause-Effect method dictates that every effect on the business is related to the cause. The consumer’s income, their confidence in the business, unemployment rate, etc. directly influences the sales figures. The goal of this method is to find the connection.

Tax Preparation Enablement

We provide your organization a true end to end solution to all of your tax needs. Tax season is year round to Protea – if you aren’t preparing daily, it’s too easy to get behind. We are always working with your organization to streamline your businesses tax management.

Tax Preparation Enablement

We provide your organization a true end to end solution to all of your tax needs. Tax season is year round to Protea – if you aren’t preparing daily, it’s too easy to get behind. We are always working with your organization to streamline your businesses tax management.

Tax Preparation Enablement

We provide your organization a true end to end solution to all of your tax needs. Tax season is year round to Protea – if you aren’t preparing daily, it’s too easy to get behind. We are always working with your organization to streamline your businesses tax management.

Tax Preparation Enablement

We provide your organization a true end to end solution to all of your tax needs. Tax season is year round to Protea – if you aren’t preparing daily, it’s too easy to get behind. We are always working with your organization to streamline your businesses tax management.

The Basics of Financial Statements

The Basics of Financial Statements

A key aspect and skill in managing a company is the ability to understand financial statements. Because we operate in a competitive business environment, it is important to be able to identify a company’s financial position/health, business trends and risks at an early stage. The ability to analyze your company’s financial statements forms a key part in cultivating overall growth.

 

Let us dig into the basics of financial statements:

 

The Balance Sheet

The foundation of the balance sheet reflects the “book value” of a company at a specific date, also known as the reporting date. The balance sheet provides a clear overview of the company and can be divided into three components namely, assets, liabilities, and owners’ equity.

Assets: Anything that the company owns or is owed, and represents an accurate quantifiable value can be attributed to this asset.

Liabilities: Any legal obligations owed by the company to third parties. In a simplistic term, liability can be seen as the opposite of an asset.

Owners’ Equity: this refers to amounts invested by or owed to shareholders. If you had to subtract all the liabilities from all the assets you should effectively arrive at the owners’ equity value. The amount reflects the net worth of the company that belongs to the shareholders.

The term “balance sheet” is indicative of one important accounting principle which is that it should always balance according to the well-known formula: Assets = Liabilities + Owners’ Equity.

 

The Income Statement

The income statement (also referred to as the profit & loss statement) is an accurate record summary of revenue, expenses and other transactions over a given period. This is a particularly important document that allows you to analyze the progress and performance of your company. You can easily determine if your company is making a profit or loss, analyze expenditure/costing, identify business trends, etc.

The Income statement typically includes the following basic information:

Revenue: The amount that the company earned from sales.

Costs of goods sold (COGS): This figure is the cost of what it took to produce your goods. A simple way to put it, for each product that you sold, how much did it cost to make and get it into the hands of the customer.

Gross profit: This is the total revenue less the cost of goods sold.

Operating expenses: These are costs incurred to keep your company operating but aren’t direct materials or labor related to producing your goods or services. Examples of operating expenses include property insurance and taxes, building repairs and maintenance, utilities, administrative staff wages, etc.

Operating income: This is the income amount that reflects the gross profit less the operating expenses (other than COGS).

Net income: This is the company’s profit after all expenses and taxes.

The income statement provides you with a good indication of how well your company is performing. You will also be able to analyze financial trends on profitability, excess expenditure, cost-saving and if there is any excess cash to invest back into your company.

 

The Cashflow Statement

This cash flow statement provides a detailed overall view of what has happened to the company’s cash and the movement of cash over a given period. It is vital that a company has enough cash on hand to meet its obligations. A cash flow statement is typically broken into three sections namely, operating activities, investing activities, and financing activities. This allows for the reader to determine the following:

  • Operating activities indicate whether a company can generate cash from their normal operating activities (selling their goods or services).
  • Investing activities indicate the cash earned or spent from investments. This can include buying/selling physical property, vehicles, fixed deposits, patent rights, etc.
  • Financing activities indicate the cash raised/spent to settle debt and/or equity financing.

 

A positive cash flow figure reflects more money coming in than going out. A negative cash flow figure reflects more money flowing out (being spent) than flowing in. A negative cash flow figure is not necessarily a bad indication and this can relate to various strategic cash flow expenditure by management. The cash flow statement is vital when it comes to decision-making pertaining to the company’s cash position. It portrays the ability of a company to operate in the long term and short term based on the in and outflow of cash. Knowing this not only allows you to plan and budget in the long term, but also allows for better short-term strategical decision making.

 

Bringing it all together can provide meaningful information

 

Whilst accountants work with financial statements on a daily basis and for them it is second nature, the same cannot be said for all business professionals and it sometimes becomes difficult to understand the financial jargon. You can however learn the basics of understanding financial statements and the benefits it can yield when it comes to analyzing the statements. Financial analysis of the balance sheet, income, and cash flow statements can provide useful information such as:

 

  • The financial health of the company
  • Assist with financial forecasting, budgeting, and cash flow planning
  • Maximizing gains or minimizing losses
  • Identifying trends and new opportunities to grow the company
  • Identifying and avoiding undue risk
  • Improving and visualizing strategic business decisions
  • Allows investors to analyze the profitability and market value of the company and decide whether they would like to invest

 

The possibilities of financial analysis and the usefulness of metrics are endless. It is important to have accurate financial statements prepared by experts that will provide you with invaluable data to analyze. The data itself won’t save your businesses – only you can.

 

Protea Financial is Your Outsourced Bookkeeping and Management Accounting Services:

 

The good news is that you can learn how to interpret financial statements even if you do not have a financial background. At Protea Financial we match our solutions to the needs of the customer. Protea Financial can support you with everything from bookkeeping services, preparing financial statements, order processing, inventory tracking, handling management accounts, and tax schedules in order to support your tax accountant. Protea’s goal is to provide timely, accurate, and high-quality financial information on which a business can act. We can work with you to provide an evaluation and find the best solution for your business.

 

 

 

 

 

Protea Conversations: Destiny Burns

Protea Conversations: Destiny Burns

Protea Financial was founded in 2014 to provide high quality out-sourced accounting at an affordable price.  Given Protea’s flexible work environment, the Company especially appealed to accountants who wanted to re-enter the work force after taking time off to start a family. This allowed Protea to attract extremely talented individuals who were overlooked.  Over 80% of both Protea’s leadership and accounting teams are women.

We selected the name Protea because is the national flower of South Africa and is a symbol of our connection. The Protea flower has become an ornamental flower because of this striking beauty and is included in arrangements and bouquets as a symbol of courage or daring to be better or a sign of positive transformation.

Protea Conversations focuses on a successful woman in business and their achievements.  The hope is that these conversations will create a forum to discuss the experiences, opportunities, and challenges women face, and how we can build a more diverse, inclusive, and successful environment for everyone.

Destiny Burns is a native Clevelander (born and raised in Euclid), and she recently moved back home after more than 30 years to be near family and to live my dream of opening an urban winery here in her beloved hometown. Destiny is a retired U.S. Navy officer (served for 20 years on active duty (thank you!), and then spent more than 13 years as a business development executive in the defense industry in the Washington DC area. Destiny is also a former volunteer firefighter/EMT and has a great love and respect for first responders and for all those who serve our country and communities in uniform.

Wine has always been a great passion of hers having lived and traveled all around the world throughout her adult life, studying and enjoying wine and food. Destiny has advanced degrees in Business and professional experience in all aspects of business development, marketing and management, and also pursued formal and informal training and professional development opportunities in the wine industry. All of her experience and education, combined with a passion for wine and for her wonderful hometown, has culminated in her decision to open and run her own winery in the metropolitan Cleveland area and provide the “wine companion” to all the great craft beer and spirits made here! As they say, let’s have fun, celebrate, connect, support charitable causes and drink some great wine together at CLE Urban Winery! 

How did you get into the wine industry and how did you come up with the concept of CLE URBAN WINERY?

I always wanted a food- or wine-related business of my own as a “someday” dream. When I turned 50, newly divorced after a long marriage with an adult child fully launched, I decided to get serious about achieving this dream. I left my high-pressure career in the Washington DC area and returned to my hometown of Cleveland, Ohio to open my own business.

After performing a market analysis, I decided that opening a restaurant was too risky (too much competition), but I discovered that I absolutely loved the craft brewery culture of Cleveland. I decided to build my business based on my love of wine and my hometown, so I created a craft brewery-style urban winery and Tasting Room in a 100 year old former auto repair garage in my suburban Cleveland neighborhood. I call it Good Wine Made Fun that Celebrates Cleveland and Creates Community, and I will celebrate my 5 year anniversary this July!

 

What has been the biggest challenge you have experienced in reaching your current success (personally and professionally)?

I would say the biggest challenge that I have faced as an entrepreneur (aside from COVID-19, which has presented a number of significant challenges for all of us) is really understanding the costs, key performance indicators and other financial measures of my business. The unique business model I created is a bit of a hybrid, and I struggled with generating the financial reporting I needed to truly understand how to profitably manage and grow the business. I finally found my financial bookkeeping partner in Protea Financial – I can’t say enough good things about how they have helped me truly understand the unique financial aspects of my urban winery business model and to effectively manage my books. The resulting financial confidence has been a godsend as I have worked to successfully navigate my business through the COVID-19 crisis.

 

What are your short term goals of your career/business and yourself?

I think I have the same short-term goal as many other small business owners… to survive the pandemic, both personally and professionally. Both aspects are challenging in this stressful and unpredictable environment, and that is doubly so as an entrepreneur. I have had to continually hustle and pivot throughout this crisis – no staying home and making a sourdough starter for me!
The other short term goal that I have been working on in 2021 is to launch the Urban Wine School™ – a comprehensive wine appreciation and education learning community that is affordable, accessible and fun! I plan to bring the first courses online this spring.

 

What is the best piece of advice you have ever received that has helped you in your success?

The best piece of advice I ever received was from a former boss who once told me that “Hope is not a strategy.” The only way you will be successful is through hard work and by developing a strategy and executing a plan to get you where you want to go… just hoping everything will work out is not going to get you very far.

  

What is the piece of advice that you wished you had gotten when you were starting out?

I knew this when I started out as a small business owner, but I didn’t fully understand how important this advice was until I was neck-deep in it… CASH IS KING.

  

What advice you give to others to help them be better leaders?

Don’t be afraid – and the best way to mitigate that fear is through knowledge. Do your homework, leverage resources, work hard and stay focused. Don’t take no for an answer. Set clear expectations and goals, and then hold yourself and your team accountable for achieving them. Surround yourself with great people and do everything you can to make them successful and productive, both personally and professionally – they, in turn, will then take care of you and your customers.

 

As a thank you to our interview and Protea’s commitment to more diverse and inclusive leaders, Protea will make a donation to Vital Voices. Vital Voices Global Partnership is a global movement that invests in women leaders who are solving the world’s greatest challenges. They are “venture catalysts,” identifying those with a daring vision for change and partnering with them to make that vision a reality. They scale and accelerate impact through long term investments to expand skills, connections, capacity, and visibility. Over the last 22 years, we have built a network of 18,000 change-makers across 182 countries who are collectively daring to reimagine a more equitable world for all.

Tax Preparation Enablement

We provide your organization a true end to end solution to all of your tax needs. Tax season is year round to Protea – if you aren’t preparing daily, it’s too easy to get behind. We are always working with your organization to streamline your businesses tax management.

5 Key Elements Influencing the Accounting and Finance Hiring Environment in 2021

5 Key Elements Influencing the Accounting and Finance Hiring Environment in 2021

 

In my first 19 years of recruiting Accounting and Finance Talent, the number 1 job benefit Professionals wanted was the flexibility to work from home- at least partially.  This was always desired more than it was available.  Employers cited security, teamwork, synergy, oversight, systems limitations, and a whole host of reasons for resisting the coveted work from home arrangement.

Enter the most significant Public Health Crisis of many of our lifetimes: COVID-19. Suddenly, many people were forcefully shoved into remote working due to Shelter in Place orders.  This dramatic shift has given many people the opportunity to fully live the work-from-home life and has offered us many new gifts, including terms like “Suit Mullet” referring to professional attire on top for Zoom meetings and pajama pants and slippers on the bottom.  Some people love it, and some people can’t wait to return to the office.  Most people are somewhere in between. 

Despite a nosedive in employment rates in March, April and May of 2020, Accounting and Finance professionals generally maintained their positions and salaries with the exception of industries tied closely with hospitality, travel, or other government shut down businesses.  With vaccines being more widely available and economic recovery underway, we find ourselves stepping into a changed work force and way of operating as business owners, managers, and employees.  The way we work has changed, the way we hire and onboard has changed. 

The entire job market that is emerging out of 2020 is different from before.  These are the Top 5 Key Elements Influencing the Accounting and Finance Hiring Environment today.

 

 guy with paper fanning

 

Resignations are abundant.

The most recent JOLTS Report (Job Opening and Labor Turn over Summary Report published by the Bureau of Labor Statistics) Shows that there were 3.3 Million Voluntary Resignations compared with 1.8 Million Layoffs and Discharges.

There are 4 main reasons why resignations are outpacing terminations and layoffs at nearly a 2 to 1 ratio.

  1. The first being economic drivers. For many years now Professionals stand to earn a larger pay increase by taking on a new role at another company rather than getting promoted at their current firm. Studies show that a change in Employer offers an average pay increase of 14% versus the average Promotion offering an 11% increase in compensation.
  2. Secondly, remote work makes it much easier to look for and interview for new positions. Gone are the days of making up a fake Doctor’s Appointment in order to meet with a potential employer. Zoom interviews and lack of oversight create a ripe environment for job seeking!
  3. Thirdly, with the demands of working from home and in many cases homeschooling, parenting or caring for other family members, many people are bowing out of the workforce to have more balance and support their families where hired support may be unavailable or unsafe.
  4. Finally, the Baby Boomer Generation has reached retirement age, and with the Stock Market’s strong performance, many people have financially recovered enough to retire.

 

bunny slippers

 

There is a rub between Remote Work expectations and Post Pandemic Plans.

 

Some people can’t wait to get back into the office. Some people never want to go back. There is a rainbow in between. Whatever your position is, does it match that of your Employer or employees? Many people have changed their view on how often they desire to commute to work even when it is totally safe to do so. The trend seems to be that employees wish to continue working from home 3-4 days a week or entirely, where employers remain hopeful that a more regular in office working style will return. This poses challenges in employee retention as well as gaining long-term commitment from potential new hires.

 Pent Up Demand.

According to a recent staffing industry survey, 45% of CFOs plan on bringing back laid-off or furloughed employees. 42% plan on hiring for new roles that they didn’t have on staff before the pandemic hit. This combined with the increased demand for Accounting support and financial analysis to navigate new market conditions, Paycheck Protection applications and forgiveness, and compensating for the resignations; there is Pent Up Demand for hiring. In short, COVID threw us all for a loop! We had to adjust to working from home. For many people this was for the very first time and meant many organizations needed to learn how to onboard staff remotely. It took us awhile to get this down, while emotionally managing fear, uncertainty, and in some cases personal stress and loss as a result of COVID and the resulting life changes. Now we have mostly adjusted, and although “#zoomlife” is not perfectly smooth, hiring managers feel ready to hire and confident enough or short-staffed enough to give it a go.

 

 

Compensation Divide.

Never before have I seen such a swing in compensation from company to company. I’ve seen industry Salary insights that quote the Bay Area as offering Salaries at 25%, 28%, and even 40% above the national average. What is true?! The truth is there are absolutely people working in downtown San Francisco using the same skills working for roughly the same size company making salaries that differ by more than $40,000/year.

Why is this? There has always been a variance between what different employers offer to attract and retain employees. However, today the divide is greater for several reasons. One, the Paycheck Protection Program stepped in and protected the compensation of many employees, but not all. Additionally, with some companies embracing remote and hiring workers in less expensive areas and others limiting their hires to their local region, pay rates have SWUNG! Another ingredient in the new comp divide is we are no longer asking candidates what they earned in their previous jobs. It’s been illegal since 2017 according to California Labor Code 432.3! Based on candidates’ pay desires, positions that have changed employee seats may have had to move up in comp faster than those roles that had retained talent since before before that employment law changed.

 

 

Burn Out.

Hiring Managers and Jobseekers alike have all just survived 2020, and it was a trying time for most people. Burnout is rampant! Many Accounting and Finance professionals that I have spoken with have cited that they have worked more consecutive hours thru the pandemic than ever before. With no natural coming and going flow of life, lack of commute, lunch breaks and water cooler conversations, the constant screen and zoom time- people are fried. Who would ever think we would look back on our commute time with nostalgia?? The other huge element contributing to burnout is the lack of novelty in our lives. Vacations to look forward to, parties, concerts, hugs from a loved one, going to the spa or salon, or a sporting event- even coaching your kid’s soccer team are all things that tend to offer a re-charge to many people, and those are all activities that in many areas have not yet returned. This is affecting the hiring environment in the way of diminished optimism and confidence in searching, hiring and overall zest for and zeal in our business lives and certainly for taking on new opportunities.

In summary, employers who can express to potential hires and existing staff how they help their employees conquer burnout, maintain a flexible working arrangement, and receive highly competitive compensation are winning the battle on talent. It truly is a battle out there, and with more Accounting and Finance professionals leaving the job market every day than entering, the companies who win this battle will also win the war.

Protea Conversations: Nastassia Lopez

Protea Conversations: Nastassia Lopez

Protea Financial was founded in 2014 to provide high-quality out-sourced accounting at an affordable price.  Given Protea’s flexible work environment, the Company especially appealed to accountants who wanted to re-enter the workforce after taking time off to start a family. This allowed Protea to attract extremely talented individuals who were overlooked.  Over 80% of both Protea’s leadership and accounting teams are women.

We selected the name Protea because is the national flower of South Africa and is a symbol of our connection. The Protea flower has become an ornamental flower because of this striking beauty and is included in arrangements and bouquets as a symbol of courage or daring to be better or a sign of positive transformation.

Protea Conversations focuses on a successful woman in business and their achievements.  The hope is that these conversations will create a forum to discuss the experiences, opportunities, and challenges women face, and how we can build a more diverse, inclusive, and successful environment for everyone.

In February 2021 we spend time with Nastassia Lopez. Nastassia is a partner in Booker and Dax, a kitchen equipment design company. Additionally, Nastassia co-hosts the weekly podcast “Cooking Issues,” with host Dave Arnold, the highest-rated show on the Heritage Radio Network. She also co-founded Pasta Flyer, the critically-acclaimed, fast pasta concept with Chef Mark Ladner. 

Nastassia also created the controversial Wine Santa and introduced it to bars and restaurants in NY and LA. Dave hates it because he didn’t think of it.

Prior to her work with Booker and Dax, Nastassia opened Salumeria Rosi with Chef Cesare Casella in New York’s Upper West Side in 2010. She also managed the Culinary Technology Department at the French Culinary Institute with Chefs Nils Noren and Dave Arnold before launching Booker and Dax.

Nastassia currently sits on the Culinary Board of the Museum of Food and Drink, and the Junior Council at the American Museum of Natural History. 

Nastassia worked in restaurants to pay her way through Stanford University, where she earned degrees in both Creative Writing and Communications. In 2015 she graduated from Stanford Business School’s Entrepreneurship Program. She lives in Hell’s Kitchen and has a passion for hosting and entertaining.

Now, this is what we call a successful leader.

 

 

How did you get into the food industry and specifically your current role at Booker and Dax?

I paid my way through college by working in restaurants in Palo Alto (I went to Stanford). I was the first in my family to ever attend college. I hated working in restaurants—I would see a lot of my classmates come in and I’d have to climb under their table and fix the wobbly leg or pretend I knew the difference between Grey Goose and Absolut when making their bloody mary. When I graduated, I resolved to never work in food again. I went on to work in music at MTV and fashion. On a trip to Italy to visit a former roommate when I was 24, I remembered how much I loved food. When I got back to NYC, I applied and started working as the assistant for Italian chef, Cesare Casella. The Food Network had just launched, and “foodie” wasn’t a thing yet. Cesare introduced me to Dave Arnold, who was/is a crazy, food tech, philosophy undergrad at Yale/art master’s at Columbia. Dave and I became friends for a few months, and then eventually became business partners because we both realized we had similar weird backgrounds, but also loved food and could think strategically.

 

 

What has been the biggest challenge you have experienced in reaching your current success (personally and professionally)?

Misogyny, verbal abuse, psychological abuse, some physical abuse. This industry is no joke, and I’ve had to act like one of the guys to get by, while also taking on a lot of shit.

 

 

What are the short-term goals of your career/business and yourself?

Sell our business to a larger company, and do something completely different career-wise after that. 

 

What is the best piece of advice you have ever received that has helped you in your success?

Be nice, work hard, and never sign the contract.

 

 

What is the piece of advice that you wished you had gotten when you were starting out?

Don’t hold on to the way things “should be.” Everything changes in ways that you will and won’t be prepared for, so don’t try to control the environment or the outcome. Ride the wave and be flexible. Everything usually always shakes out the way it’s supposed to. Worrying and fretting makes you age faster and does absolutely nothing for you.

 

 

What advice you give to others to help them be better leaders?

Managing people is incredibly hard, and trusting a team execute your vision is even more difficult. Go with your gut if someone isn’t working out. Don’t waste time thinking they’ll “get better.” Cut them as soon as you feel they’re not on course.

 

As a thank you to our interview and Protea’s commitment to more diverse and inclusive leaders, Protea will make a donation to Vital Voices. Vital Voices Global Partnership is a global movement that invests in women leaders who are solving the world’s greatest challenges. They are “venture catalysts,” identifying those with a daring vision for change and partnering with them to make that vision a reality. The scale and accelerate impact through long-term investments to expand skills, connections, capacity, and visibility. Over the last 22 years, we have built a network of 18,000 change-makers across 182 countries who are collectively daring to reimagine a more equitable world for all.

Tax Preparation Enablement

We provide your organization a true end to end solution to all of your tax needs. Tax season is year round to Protea – if you aren’t preparing daily, it’s too easy to get behind. We are always working with your organization to streamline your businesses tax management.

Accrual Accounting vs. Cash Accounting – What’s the Difference?

Accrual Accounting vs. Cash Accounting – What’s the Difference?

There are two methods for recording financial transactions in your books—the cash basis and the accrual basis. The primary difference between these two is the timing of when transactions get recorded.

Choosing a method depends on your business’s needs, and most wineries should use the accrual basis to value inventory properly. However, we’ll discuss both ways so you can see how each impacts a business.

Cash Basis Accounting

The cash basis of accounting records financial transactions when cash changes hands. When you receive money from customers, you record revenue. And conversely, when you pay your bills, you’ll record the expense. It’s that simple.

Although the cash basis of accounting generally doesn’t comply with Generally Accepted Accounting Principles (GAAP), it’s widely used by small businesses and new companies due to its simplicity.

And using the cash basis doesn’t necessarily require hiring an accountant with years of experience. A competent bookkeeper will easily be able to keep your cash-basis books.

 

Accrual Basis Accounting

Recording revenue when it’s earned and expenses when they are incurred is the basis of accrual accounting. When cash is received or used is irrelevant to the recording of the income and expenses

The foundation behind accrual accounting is the matching principle. This means that companies match expenses with related revenues to calculate profitability for a specific period.

For example, when you sell a case of wine, at the same time, you need to record the cost of the wine and any related selling expenses so, at the end of the day, you know your profit on the sale of that case of wine. 

Accrual accounting will make use of accounts receivable and accounts payable to keep track of money owed to you and money you owe to others. These accruals allow you to match your expenses with the corresponding revenue.

For example, when you ship 20 cases of wine to your distributor with an invoice, those 20 cases’ sales price becomes a receivable to you. You earned the revenue by completing the sale but haven’t yet received payment.

 

The converse works for the money you owe to others. When you receive a shipment of glass bottles from your supplier, you incur the expense when you receive them. But you may not pay that invoice for 30 days, so you’ll have a payable on your books for the value of the bottles. Accrual accounting is more complex than cash accounting but does provide a truer picture of the profitability of your business.

 

Most larger companies and companies with numerous owners are required to use accrual accounting to adhere to GAAP principles. In fact, the IRS also has requirement on when accrual accounting must be used, namely for.

 

  • most businesses with inventory,
  • C-corporations, and
  • companies with more than $25 million in annual sales.

Examples of Effects of Cash and Accrual Accounting

 

Effects on Income

Assume you sell 100 cases of wine for $1,000 to your top distributor and the total cost of making, bottling, and packaging that wine was $500. 

Cash basis

You record the $1,000 in revenue when your distributor pays you.

You record the costs for the grapes, labor costs, bottles, etc. when you pay for those items, which was likely long before you sold the wine.

Gross profit reported at the time of receiving the cash from the distributor is likely to equal to the revenue.

 

 

Accrual basis

You record the $1,000 in revenue when you deliver the wine to the distributor.

You record the costs of the materials and labor at the same time that you record the sales revenue.

 

Gross profit reported at the date the wine shipped (or a different date depending on the shipping terms) and will be equal to sales revenue less the cost of the wine.

 

You can see how the cash basis doesn’t provide a good representation of profit when your revenue gets recorded long after the expense shows up on the income statement.

 

 

Effects on Taxes

Using the same example of 100 cases sold for $1,000 at a cost of $500, the tax effect creates a similar mismatch.

 

Cash basis

You probably (due to the length of the inventory cycle in wine) recorded most of your costs in previous years, making your taxable income lower in those years.

But this year, when you record the $1,000 in revenue, your taxable income will be higher because you don’t have the offsetting expenses.

 

Accrual basis

This year, you’ll be taxed on your $500 profit on this sale since you’ll record revenue and expenses in the same year.

You’re starting to see that the accrual basis creates more of a steady financial environment than the cash method’s peaks and valleys. Accrual accounting provides a clear picture of the profitability of a business as the income and expenses are matched.

 

 

 

Which is Better? Cash Basis or Accrual Basis

Choosing the correct accounting method will depend on your business’s specifics. Things to consider when deciding on a method include:

 

  • Do you think you’ll need bank financing in the future?
  • Is expanding the business to include more owners a possibility?
  • Will your books ever need to be audited?

Cash Basis

Pros
Cons
Simple and easy Inaccurate financial picture
Easy cash flow management No records of what you’re owed or what you owe
Good short-term view Doesn’t comply with GAAP

 

Accrual Basis

Pros
Cons
The better overall financial picture Requires more resources
Commonly expected in business The short-term picture can be skewed
Conforms with GAAP

 

Once you pick a method, you’ll want to stick with it for two reasons. Firstly, for consistency in your financial information. This way you’ll always be comparing apples to apples. Secondly, the IRS requires you to maintain the same method. If you ever want to change, you’ll need to ask for the IRS’s permission.

It’s best to consult with your accountant when selecting the accounting method that’s best for your winery and could be different for operational needs and tax needs. They can help you set up your accounting system and processes to ensure you’re recording your transactions correctly. You can also lean on them when you need expert help or additional hands to get the work done. Protea has decades of experience helping winery owners navigate the bookkeeping, accounting, and tax waters. Contact us today to see what we can do for you.