Accruals and Deferrals
In accrual accounting a financial transaction is recorded when it occurs but not when cash has been paid or received. This is because; the ownership of good in question has been transferred from the seller to the buyer. For example, many businesses opt to sell in credit so as to enhance their competitiveness in the market as well as to keep their loyal credit worth customers who may not have adequate cash to pay immediately in such cases a transaction should be recorded at the time the credit sale has been made.
Accruals are inevitable when making supplies because in many cases clients may not have ready cash probably because they have not been paid by their customers or they lack adequate capital. In such cases supplier must make use of account receivable. This account records all goods sold or services offered to client on credit basis. Therefore, account receivable can be taken as the account of accruing revenue.
It is also common in supply chain that one may be a middle man. In this case, one may obtain some goods on credit may be because he does not have enough cash to purchase adequate stock. In this case one should prepare an account payable. This account is supposed to record all goods received or services received but, the payment has not been made. Therefore, a supplier should keep account receivable and payable so as to recognize all transaction upon their occurrence as per generally accepted accounting principles.
With the knowledge of accruals one is able to differentiate between recognition of a transaction and realization of cash. Whereby, a business should always record a transaction when it has taken place not necessarily when cash is paid or received.
On the other hand, deferrals occur when cash payment is done before revenue is earned. Thus, deferral is the presents a case of unearned revenue. It mainly occurs when dealing with a new client or dishonest clients who cannot be supplied with goods or offered service before paying. However, it can occur when the policy of the company is to receive cash on order.
The case of prepayment brings about additional deferrals in business. For example, when renting a warehouse the owner may request to be paid before using the ware house. This expense cannot be debited in profit and loss account because it has not been incurred when raising the income of the financial period. It is therefore that, business recognizes a transaction when it has taken place but not when money has been paid in addition, any money paid in advance is a pre payment which should be considered as current asset.
Analyzing financial statement
Financial statement can either be analyzed vertically or horizontally. Horizontal analysis compares one value across several periods. Whereby, one year is taken as base year, and then the difference between each year and base year is expressed as a percentage.
If one is evaluating performance of a company in terms of how it’s performing over a given period of time in terms of stock turnover, 2005 can be taken as a base year then the respective percentages of 2006, 2007, 2008, 2009, 2010 and 2011 can be calculated. These percentages will create a trend if it is increasing it suggest that the company’s sales have been increasing while decreasing percentages over time indicates declining sales. When this analysis is done for different outlets which are selling company’s commodities it becomes simple to know which outlet is likely to make largest sale in coming years. This is done by using trend formed by the percentages to predict future performance. The horizontal analysis can be applied on every item on the financial statement and the necessary prediction made based on the trend obtained
On the other hand, vertical analysis compares each item in financial statement to a base number which is set as 100%. For example, sales can be taken as base item and respective percentages of cost of sales, gross profit margin and expenses can be calculated.
A part from horizontal and vertical analysis there is the ratio analysis which enables comparison of performance of companies of different sizes. Among these ratios the current ratio is important in supply chain management because it determines whether a company will be able to pay its current liabilities as they fall due. This ratio can help to determine whether intermediaries who obtain goods on credit will be able to pay back in time. If the current ratio of an intermediary has been declining he should be advised to be strict when offering items on credit. To manage supply chain effectively a company should put in place a policy regarding the least acceptable current ratio of any intermediary which sales its products this ratio should be above one. An intermediary whose current ratio falls below the threshold should not be offered goods on credit because he may not be able to repay in time. Excessive delays in paying current liabilities, if allowed, may lead to bad debts which decrease company profitability.
The inventory turnover can be used to determine how an intermediary is converting company’s stock to sales. If the turnover is low strategies should be put in place to increase sales. Such strategies are increased promotion of a commodity or even checking the pricing of commodities. However, before making a conclusion on the performance of a company ratio of different years and companies in the same industry should be considered.
Analyzing statement of cash flows
Cash flow statement deals with movement of cash in and out of business. Movement of cash may be due to operating, financing or investing activities in a business. Activities which relate to operating cash flow are very important because they are core to business. A supplier should be able to collect cash from debtors in order to settle creditor’s dues in time. If an intermediary is always lacking adequate money to pay goods obtained in credit he is likely to bring about shorting of cash flow to those who have supplied him with goods. This will then push upward until the producer is affected hence disrupting companies operations. To avoid this, it is important to prepare a cash budget which outlines all possible sources of cash and ways in which the cash will be spent. This budget helps a business to make arrangements of external sources of finance early if it predicts possibility of cash shortage. Failure to prepare a cash budget will lead to unexpected cash shortage which may either stop business operation or make a business to obtain short term financing which may be very expensive. Therefore, intermediaries’ whose cash flow statements predict possibility of failing to repay should be supplied goods in cash basis only.
Unlike other financial statements cash flow is not prepared inconsideration of accrual basis. It is therefore possible to start calculating net cash flow by taking net income then subtracting all accruals of the given financial year. To avoid unexpected shortage of money to operate business all intermediaries should be required to prepare cash flow statement.
