Accrual accounting

A sale is recorded when it is earned, not when the money arrives, and a cost is recorded when it is used up, not when the cheque clears. That single rule is what separates a set of accounts from a bank statement, and it is the reason a profitable company can run out of cash.

Shree Balaji Furniture Works ships ₹12,00,000 of hotel furniture in March on 90-day credit. Under accrual accounting the whole ₹12,00,000 is March revenue. If the wood, labour and freight behind that order cost ₹9,00,000, March profit is ₹3,00,000, even though not one rupee has been collected and the March bank balance may have fallen.

Cash arrives in June. Until then the ₹12,00,000 is carried as trade receivables on the balance sheet, and the gap between profit and cash shows up in the operating section of the cash flow statement. Until June, the company looks richer in its accounts than it does in the bank.

Accrual cuts both ways, so it pays to understand it. Electricity consumed in March and billed in April is a March cost even though the money leaves later. Insurance for a year, paid in advance in January, is spread across the twelve months it covers, so January carries only its own month. Both adjustments make the reported profit a better description of the period than the bank statement would be, and both open a door: the size of an accrual is a judgement, and judgements can be steered. Many accounting scandals begin as an accrual pushed further than the facts supported, and some go on to invent the cash as well, as Satyam's fictitious bank balances showed.

Accrual is the more truthful measure of a period's economics and the easier one to manipulate. Both facts matter.

Cash is harder to fake than an accrual, but it can be faked. So confirm that the balances exist, and read how operating cash flow was produced.