Use of Accrual vs Cash Systems of Accounting Ted Mitchell

Accountants Seek to match costs and revenues over time You buy a pastry machine for $7,200 and it is expected to make pastry for 2 years A cash system of reporting would write off the $7,200 as an expense in the first week Huge losses being reported in the first week and inflated returns for next 23 weeks An accrual system divides the $7,200 cost of the machine into 24 charges of $300 each and reports the expense as $300 cost a week to provide a more realistic view of the amount being earned each week

Start up Costs for 1 Month Fixed expense Rent for Month $2,000 Utilities per month $500 You will have inescapable fixed overhead costs of $2,500 every month Or $625 in cash each week

Start up Costs for 1 st Month Fixed Monthly Cost Minimum Sunk or Start up Maximum Sunk or Start up Rent for Month $2,000 Utilities per month $500 Buy a Coffee Maker $3,000$6,000 Buy Furniture $2,000$4,000 Total$5,000$10,000 You will sink between $5,000 and $10,000 into the business in the first month

Start up Costs for 1 st Month Fixed CostMinimum Cost in Month 1 Maximum Cost in Month 1 Rent for Month $2,000 Utilities per month $500 Coffee Maker $3,000$6,000 Furniture$2,000$4,000 Total$7,500$12,500 You will spend between $7,500 and $12,500 in cash into the business in the first month

Starting Biz-Cafe You get $25,000 You will spend $7,500 to $12,500 for equipment and rent to run for 1 month and quit the business Leaves $17,500 to $12,500 to hire employees, buy coffee and cups, do advertising, etc. Given the start up costs can you make a profit in one month? Your Accountant is Using an Accrual system!

Accrual System Can spread the reported cost of the coffee machine and the furniture out over a five year time frame But there is still the cash outflow when the things are bought

Cost for per month with hopes to run for 60 months (5 years) FixedSunk in month 1 Allocated by 5 year Depreciat Sunk in month 1 Allocated by 5 year Deprecia t Rent for Month $2,000 Utilities$500 Coffee Maker $3,000$50$6,000$100 Furniture$2,000$33.33$4,000$66.67 Total$15,000$2,583$20,000$2,667 Using Depreciation to match costs to revenues over time The monthly cost is reported between $2,583 and $2,667 a month

Cash Flow is NOT The same as the Amount as the Profit Flow over any given reporting period Daily, weekly, monthly, annual

Difference between Cash and Accrual Reporting Cash Reporting is simpler but makes the profit picture for the first week, month, year, etc. look terrible Depreciation makes the profit picture in the first month look considerably better But the actual hit on the cash reserves is still real Depreciation is not a fund of money for replacement. Accrual accounting is a procedure for matching costs and revenues over time!

Cash Flow Report in the Game Is the Checkbook: Is usually out of sync with the monthly revenue and the profit flow Accrual system to try to match costs and revenues so that shareholders have a better understanding about the return on their investment

The Profit Flows in the game are reported in 1) The Monthly Income Statement 2) The Monthly Balance Sheet

Starting Biz-Cafe You get $25,000 Depreciation gives us the false sense of cash profits by trying to match costs and revenues over 60 months But the game goes for a maximum of 16 weeks Your inescapable costs are reported to be between $2,583 and $2,667 per month! But Decisions are weekly!

You as Marketing managers will find The classic monthly accural-based Accounting Reports – Balance sheet (important for retained earnings) – Income statement To be inadequate for making profitable marketing decisions You will be wanting a weekly marketing performance report that

Two very useable weekly reports The Dashboard Report And The Weekly Sales Receipts Report

You will want to build a weekly marketing manager’s report On a spreadsheet constructed for the reporting of a weekly marketing performance It will include: Price, Demand, Revenues, Cost of Goods Sold, Gross Profit, Direct Marketing Expenses for the Week and Marketing Profit!

Any Questions 1) What is an accrual system of reporting 2) Why is it used rather than a cash flow for reporting profit 3) What is the cash flow report in the game? 4) What are the accrual reports on profits 5) Why a weekly marketing report is needed?