Have you ever tried to start a small business? If you have, did you record all the transactions occurred whether it was in black-and-white or in bits-and-bytes? Did you keep track of the record? And how did the business operation result after a while? Did it suffer a loss because many a customer preferred to buy your goods (or to get your services) on account (on account means to be paid for later)? Well… don’t lose hope. Declining in cash amount is not always attributable to incurring a loss, at least that’s what accountants and bookkeepers think about it. Let’s take a brief example below which is presented the first seven day operation transaction data of a small business.
Day 1. Suppose, Mr. Hartana Dekry, a dentist, had an intention to open a clinic. And to start with, he invested US$ 30,000 in cash and US$ 40,000 in equipment.
Day 2. Performed a service to Ms. Tutinonka receiving US$ 200 cash.
Day 3. Paid rent for the month US$ 150 cash.
Day 4. Paid for electricity US$ 100 cash.
Day 5. Performed a service to Mr. Al Jupri gaining US$ 300 on account.
Day 6. Performed a service to Mr. Boyindra gaining US$ 250 on account.
Day 7. Paid US$ 100 cash for telephone bill.
Now from the data given above, let’s try to compose a simple income statement (In the United Kingdom, it is called “Profit and Loss account”) of Mr. Hartana Dekry for the first seven day period of operation:
|Mr. Hartana Dekry
For The Period Ended Day 7
|Revenue From Services||US$ 750|
|Total Expense||US$ 350|
|Profit From Operation||US$ 400|
From the income statement above we readily see that Mr. Dekry is enjoying US$ 400 profit. Wait a sec! How can Mr. Dekry enjoy a profit whilst his cash account drops in amount? You will calculate that Mr. Dekry’s cash balance now amounts to US$ 29,850, hands down, it is a US$ 150 negative swing from the initial cash balance of US$ 30,000. How can you think that it is a profit??? Aha! That’s the million thousand dollar question. In accounting, you recognise a revenue as it is gained or as it is recorded. You don’t need to wait until your customers settle the bills to claim your revenues. That’s the bread and butter of revenue recognition in accounting. You have to do away with cash-oriented outlook because profits and losses are way beyond the amount of cash in accounting! You can still make a profit even if most of your customers preferred to have the transactions on account. The effective losses emerged only and if only your customers’ debts become irrecoverable bad debts. The mechanism of bad debt emergence is beyond this text but possibly I will come up with this topic down the road. For now, you have to remember two simple things to keep bad debts at bay: First, if you are to allow your customers to pay for your service at a later date make sure that you single them out who have good records in paying their debts on time otherwise cash transactions are safer to deal with. Second, when the debts are due, don’t hesitate to call them to insist that they must pay up their due debts. With those two simple things above rosily the debts will not turn bad ones… As ‘simple’ as that.
- I would like to thank those whose proper nouns are misused in this text without permission . They are real but of course the transactions are fictitious. Mr. Dekry’s profession is also bogus. He is in fact a likable radio broadcaster, by and large. 😛
- How can the end balance of Mr. Dekry’s cash be US$ 29,850? To arrive at these figures, take the initial balance of US$ 30,000, then add to it the cash revenue transactions (in this case only Ms. Tutinonka that comes with cash transaction of US$ 200), then taking away the amount of all cash expenses from the new balance (US$ 150 + US$ 100 + US$ 100). In the simple arithmetic expression it is as simple as 30,000 + 200 – 150 – 100 – 100 = US$ 29,850.