Purpose: To help you understand the importance of cash flows in the operation of a small business.
It’s the end of the month and cash flow has been a little slow, as it usually is during this time of the accounting period. It just seems to be a little slower this month. You know that Wednesday the 31st is payday, which always requires a large cash outlay. However, you also know that your bank is looking for a set of financial statements as of the end of the month because the loan on your building is coming up for renewal soon. In some of the previous meetings with your bankers, you know that they were always concerned with the cash balance, so you want to have your cash balance as high as possible.
You come up with a tentative plan to preserve not only some of your cash balance at the end of the month, but also you believe it will help your bottom line, your net income. That’s the other thing that the bankers are always concerned about. You don’t want to make any mistakes with your financial statements at this crucial point, so you decide to contact your CPA to run the idea by her. The conversation goes something like this:
“Good morning, Linda. This is Jerry from BCS Consultants, Inc. Our financial statements have to look really good this month because the bank is going to be scrutinizing them pretty closely for our pending loan renewal. I know that the two things they concentrate on are the cash balance and the net income. So, I’ve got a plan to help in both of those areas. I’m going to hold off paying my employees until after the first of the month. Plus, last month, I made a big insurance payment to cover me for the next six months, so I won’t need to show any insurance expense this month. Both of those will help my net income because I won’t be showing those expenses on my income statement. Plus, by not writing the paychecks until the first of the month, I’ll be helping to show a higher cash balance. It’s really only one day, but the bank won’t know that my cash balance should be lower. These certainly sound like some good ideas that would help with my situation, but just in case, I wanted to check with you to see what you thought. Any comments?”
The first words out of the CPA’s mouth are “Jerry, you know that your financial statements are prepared using the accrual basis of accounting.”

Requirement
1. Complete the thought process of the CPA concerning Jerry’s plan. What does she mean by the accrual basis of accounting? What effect will that have on the net income? Is Jerry correct in his assessment of the big insurance payment he made last month covering the next six months? What effect will that have on the net income? And in regard to the last item, what about Jerry’s plan to keep the cash balance as high as possible and his statement “the bank won’t know that my cash balance should be lower”?