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.

The cash arrives in June. Until then the ₹12,00,000 sits in trade receivables on the balance sheet, and the gap between profit and cash sits in the operating section of the cash flow statement.

The rule cuts both ways, which is what makes it worth understanding rather than memorising. Electricity consumed in March and billed in April is a March cost even though the money leaves later, and a year's insurance paid in advance in January is spread across the twelve months it covers rather than charged to January. 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. Almost every accounting scandal in history is an accrual pushed further than the facts supported.

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

Cash never lies. Accrual explains.