How Accountants Keep Score: Are You Using the Right Method?

To successfully run a business, you have to understand how accountants “keep score” of your numbers. While most people focus solely on their bank balance, professionals use two specific methods (the cash basis and the accrual basis) to determine if a company is truly winning.

1. The Cash Basis: Following the Bank Account

Cash basis accounting is a straightforward method because it only cares about when money actually enters or leaves your bank account.

• Personal and Small Business Use: This is the method almost every individual uses for personal tax returns and most small businesses use for their filings.

• Timing Revenue: If you deposit a check in December, it counts as revenue for this year. If you wait until January, it becomes revenue for next year.

• Managing Expenses: Paying a vendor in December reduces your income for this year. If you pay them in January, it affects next year’s income instead.

• Best For: This method is most frequently used by retail stores, e-commerce businesses, and companies where the customer pays at the time of service.

2. The Accrual Basis: Tracking Real Profitability

The accrual basis is more complex because it focuses on when money is earned and when expenses are incurred, regardless of when the cash actually moves.

• Earning Revenue: If you perform a service and bill a client in November, that counts as November revenue, even if the customer doesn’t pay you until much later.

• Incurring Expenses: If a vendor works for you in November and sends a bill dated in November, it is recorded as a November expense, even if you do not pay it until December.

• Best For: This is essential for law firms, accounting firms, and consulting companies that deliver services today but receive payment at a future date.

• The Benefit: It provides a much more accurate picture of your business’s true profitability.

3. The Ultimate Survival Metric: Days of Cash

Beyond just profit and loss, accountants use a powerful metric called Days of Cash to measure a business’s resilience and how long it could survive if income stopped.

How to Calculate Your Days of Cash

To find this number, you first calculate your average daily spending.

• Determine Daily Spend: If your business spends $365,000 over one year, your “day of cash” value is $1,000.

• Check Your Balance: If you have $25,000 in the bank, you have 25 days of cash.

• The Healthy Range: Most businesses should aim for a healthy position of 45 to 75 days of cash, which is roughly one and a half to two and a half months.

Why This Metric Matters

The “Days of Cash” metric is unique because it does not depend on the specific numerical dollar value in your bank. Instead, it allows you to compare the strength of your cash position today against your position in the past or future based on your business’s actual resilience and reserves.