The cash method of accounting is one where revenues are only recorded once cash has been received and similarly expenses are only recorded when cash is paid. When work is done or goods sold an invoice sent to the customer; no revenue would be recorded until the money has been received. Likewise, when the business owes debts to suppliers among other businesses, expenses are not recorded until the amount is paid. In the accrual basis of accounting, on the other hand, income is recognized and recorded immediately it is earned and expenses recorded immediately they are incurred whether the actual payment has been made or not.
The cash basis of accounting is advantageous in that it is simple and less costly to use as compared to the accrual basis. However, one of the disadvantages of this accounting method is the fact that it is not accurate because it does not comply with the matching principle which requires that revenues are matched with the expenses incurred in generating them. Consequently, the company could appear to be making profit when in essence it is making losses.
One of the advantages of the accrual basis of accounting is that it accurately measures the company’s profits because it complies not only with the revenue recognition principle but also with the matching principle. However, its main disadvantage is the fact that it is a more complex and expensive to implement than the cash method of accounting.
There are different types of loans which can be used to raise money for investing in a small business. The business person would be able to decide on the type of loan depending on the needs as well as other factors like the availability of assets to pledge as security.
There are secured loans in which the borrower pledges an asset like a vehicle, property or even land as collateral. This therefore means that if the borrower defaults in payment of this loan, the asset can be taken by the lender and sold in order to offset the debt obligation. This type of loans tends to have a lower interest rate compared to the unsecured ones because the risk associated with the loan is low. Therefore it is advisable for this business person to go for this loan as long as she has the asset to pledge as security.
Unsecured loans are loans which the borrower obtains from the lender without having to pledging any asset as security. This therefore means that should the borrower default in payment chances of getting his payment back are very slim. Since there is not asset that the lender can possess from the borrower, the only option is to seek redress from the courts with very slim chances of obtaining his money especially if the borrower goes bankrupt. Owing to this high risk, unsecured loans usually have high interest rates and therefore one should only apply for such a loan if she her business generates enough monthly income to cater for this high interest expense. This business person would therefore be advised to apply for this loan if she does not assets which she could pledge to acquire secured loans. Unsecured loans would therefore be the best option because there is not need for any asset to be pledged as collateral.
In order to effectively manage your business you have to prepare three main financial statements in the business which as a business person would have to keep watch of. These include the income statement, the statement of financial position and the cash flow statement.
Income statement is the financial statement that presents information on how much profit has been generated by the business during a given trading period. It may also indicate whether the business actually made a profit or suffered a loss during this period of time. It is a very important financial statement because it provides crucial information on the company’s expenses, revenues and profitability which is then used by the managers to understand the company’s financial performance and therefore put in place strategies to improve this performance.
Statement of financial position is a statement that provides information on the company’s assets, liabilities and therefore its financial position. This is very important as it determines the company’s ability to continue operating as a going concern.
Cash flow statement is the statement that provides information about the company’s cash inflows and cash outflows. It enables the company’s leadership to manage its liquidity which ensures that the company does not run out cash necessary for meeting several transactional obligations of the business.
In order to effectively manage the finances of the business you need to prepare financial reports at the end of every year and carry out ratio analysis. Financial report is a record of all the financial undertaking of a business, there are various financial ratios that can be used to analyze the performance of the business. They include:
Current ratios which compares the company’s current to its current liability which shows whether the company would be able to meet its debt obligations from its current assets should the creditors demand for payment. It is given by this formula, (current ratio= current asset ÷ current liability)
Profitability ratio, this ratio measures the company’s profit in relation to its sales, total assets, capital invested among other parameters. This is important as it enables the management to better understand the performance of the business and thus put in place measure that would improve it. It can be given by this formula, (profitability ratio = profit ÷ capital invested)
And lastly the gearing ratio which compares the company’s debt capital to its equity capital. It is a very important ratio in that it provides information on how much the company is relying on borrowed capital as opposed to the equity capital. This would eventually impact on its ability to continue with operations in future business the larger the debt of the business the higher chances of failure especially when all creditors come demanding for their payment. It can be given by this formula, (gearing ratio = total debt ÷ total equity)
REFERENCE
Hodgetts, R. M., & Kuratko, D. F. (2008). Small business management. Hoboken, NJ: Wiley.
