Is Cash Basis Hindering your Manufacturing Businesses Growth??

If you're a manufacturing business and operating on a cash basis of accounting - this might be the main item that's limiting your growth! In this blog post, we'll go through what are the various types of "Accounting Basis" and why as a manufacturer you may benefit immensely from a conversion to accrual basis of accounting.

BASIS OF ACCOUNTING

Believe it or not, within accounting there are various basis's of accounting for transactions. Most often you have 3; Cash, Modified Cash & Accrual basis of accounting. They all stem from when you record transactions.

In the most simplistic terms, cash basis records transactions when the cash enters or exits the bank account. Accrual basis records transactions when threshold are met, for example - revenue is recognizes when earned & expenses are recognized when incurred. Modified cash basis is dependent on each business - typically a hybrid between Cash/Accrual/Tax basis.

Below outlines the general transaction flow based on each major balance...

	Cash Basis	Accrual Basis	Modified Cash Basis (Varies by Company)
Cash	Bank Balance	Balance in Bank if all checks written cleared	Typically Bank Balances
Accounts Receivable	N/A - Doesn't Exist	Revenue customers still owe you	Typically what customers owe you
Inventory	N/A - Doesn't Exist	Cost of material & labor/OH to produce	Depends on business
Accounts Payable	N/A - Doesn't Exist	Invoices owed to vendors	Typically what you owe vendors
Accrued Expenses	N/A - Doesn't Exist	Services/goods received but not invoiced by vendor	Typically doesn't exist
Revenues	Recognized when cash is deposited	Recognized when earned (Shipped/Service rendered)	Typically when earned (Accrual)
Expenses	Recognized when cash is paid	Recognized when benefit incurred	Typically when paid (Cash)

WHY ACCRUAL BASIS IS SUPERIOR

While initially it may not seem like a major issue to utilize a cash basis or modified cash basis - monitoring your margins without the proper guard-rails in place is TOUGH!

Take for example - if you're a wholesale manufacturer of artisan salami. You purchase raw material on Day 0 (paying in cash that day). The product doesn't arrive until Day 3. It then takes you until Day 5 to manufacture the product, during this time you incurred labor & overhead costs (Rent, Utilities, etc.). The product then needs to cure & pass QC for 7 weeks, at which point it's ready to be packaged on Day 54. You then ship the product on Day 60.

In this example - on a cash basis, you would've expensed the raw material on Day 0, Labor & Overhead on Day 5, Packaging on day 54 & eventually recognized the revenue on day 60!

This would mean you're revenue would be recognized nearly 2 months after the expenses!! SIGNIFICANTLY HINDERING YOUR ABILITY TO MONITOR MARGINS! In an accrual basis, the cost of the raw material, labor & overhead is maintained in inventory as it goes through the manufacturing process to allow for you to determine on a per/unit basis - what is your margin. Allowing you to spot erosion significantly quicker.

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At CRB Advisor, we specialize as a Fractional Controller for Inventory-Heavy businesses - helping improve margin visibility & cashflow clarity.