Post #3 of 4 in a series of posts about financial records. See the bottom for a list of the 4 posts.
Every set of financial records needs a statement of operations to summarize income and expenses for the period. Often we refer to this as a statement of income and expenses, or simply an income statement.
A key concept to grasp is the difference between cash basis and accrual basis income statements.
A cash basis statement captures just the transactions that went through the checkbook. An accrual basis statement captures all of the cash transactions plus such additional transactions as are necessary to "fairly" present the results of operations.
What do I mean by that? Here are two examples:
Perhaps you sold something this year but will be paid for it next year. On a cash basis, the income will be recorded next year (when paid). On an accrual basis, the income would be recorded this year (when sold).
Perhaps you purchased and paid for extra feed or supplies at the end of the year, but they have not been consumed yet. On a cash basis, the expenses are recorded in the current year (when paid for), but on an accrual basis they would be recorded in a future year (when consumed).
The key concept in accrual accounting is matching up income and expenses in the same period. Expenses should be recorded in the same period as the corresponding income.
As lenders we generally like to look at income statements on both a cash basis and an accrual basis. Cash flow is important because that is what is needed to repay debt. But accrual income is also important because that is what reflects the true profitability of the enterprise.
Most farmers keep their books on a cash basis, because that is the most common basis for filing income tax returns. That is fine; we are used to working with that. We can usually make such accrual adjustments as are needed for our purposes by asking only a few additional questions, as long as we have good beginning and ending balance sheets.
This is part of a series of 4 posts on this subject:
Financial Records - Letter to Members
Financial Records - Reconciling
Financial Records - Cash vs. Accrual
Financial Records - How good?
