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By E. James Burton
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E. James Burton is Dean of the Jennings A. Jones College of Business at Middle Tennessee State University in Murfreesboro, TN. He holds a Ph.D in accountancy, as well as an MBA. His books include Total Business Planning, Accounting and Finance for Your Small Business, and Sales and Operations for Your Small Business, all published by John Wiley & Sons.
Q. I'm at the end of my first year of business. While my income statement shows a significant profit, my bank account has less money than when I started. Can you help me reconcile these two things?
A. There are probably at least two issues involved in the discrepancy between the amount you have in your cash account and what your income statement shows. The first involves the distinction between cash basis accounting and accrual basis accounting.
Under cash basis accounting, expenses are booked when they are paid and revenue is booked whenever it is received. Under accrual basis accounting, expenses are booked as they are incurred and revenue is booked as the services or goods are provided.
For example, you might not receive your electric bill for December until the next year. Under cash basis, it would be an expense of year two (when you paid it), but under accrual basis it would be booked as an expense in year one (when you used the electricity). Or, let's assume you had a large contract for services, which you actually completed in the last month of the year, but did not get paid for until, say, February. Under cash basis, this would be revenue in year two, but under accrual basis it would be counted as revenue in year one. So, one issue could simply be the timing differences created by having your cash account on a cash basis and your income statement on an accrual basis.
A second issue may be that all that your earnings may not be in cash. For example, if you have internally financed the purchase of any additional assets, then some of your earnings will be in other accounts. Say you bought an automobile for business use in cash and put it on the business books. If you did not purchase the car with outside financing, then some of your earnings will be accounted for in the asset "automobile", rather than in the asset "cash"--and your bank statement may look considerably smaller than you'd thought. So, your reconciliation must take that into account.
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