The company used Cash Basis accounting for their operating statements because taxes were calculated on a Cash Basis. When sales grew, profitability looked strong because cash came in within 48 hours, but the company’s bills weren’t due for 60 days. As a result, reporting always showed today’s sales with COGS from two months ago. When sales slowed, the company experienced a cash crunch for the first time.
Accurate financial reporting is critical for any company. Financial reporting must be on an Accrual Basis. Revenue and expenses for each transaction need to be aligned so that they fall into the same period—otherwise, true profitability is unknown. The bigger issue is that inaccurate reporting masks other financial issues.
To facilitate quick price moves on the internet, a homegrown computer program automatically set prices for their various on-line stores. Unfortunately, the program miscalculated costs, and in many instances, items were sold at a loss. To eliminate this problem, the company switched to well-known software that didn’t need continued testing and rewriting for accuracy.
A cash flow forecast was developed to manage the company’s cash shortfall. Knowing the amount of cash the company was going to have at any point in time allowed for better planning with suppliers for payments, future hiring, and buying inventory to support company growth.
The company had three major debtors, their bank, and two major suppliers for items the company sold. After a year of flat sales which resulted in shrinking cashflow, the company was near the top of their credit lines with all three. Intense negotiations with the two suppliers resulted in developing term notes with each.
The new financial reports and cash flow forecasts brought a clearer picture of the business’ financial position to the owners. The company’s negotiations with the two major suppliers gave them the leeway they needed to be able to purchase more inventory to build profitable sales. Within the first year, they were able to cut their AP balance with both suppliers by 30%. The owners could finally take competitive salaries for the first time in 3 years.
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