Page 167 - The UnCaptive Agent

140 THE UNCAPTIVE AGENT

Essentially, when you keep your books on a cash basis,
you only record items of income and expense when
you actually receive or pay them. While this is fairly
simple, it results in an understatement of the actual
net worth of a business because the balance sheet fails
to account for “accounts receivable.” Accounts receiv-
able are those items of income that are owed to you.
When I became a partner in my agency, we decided
to restructure it from a corporation to a limited lia-
bility company. Essentially, we started over. We were
a cash-basis corporation, and what I found interesting
was that we received commissions, especially direct bill
commissions, for a year and half after the conversion!
These unrecorded commissions were a substantial
amount of money, and we didn’t consider them at all
in our agency valuation.
Another significant disadvantage of cash accounting
is that you see distortions in profit or loss due to timing
differences in receipts or expenditures. These distortions
make it harder to accurately forecast results, particularly
as you grow. This means that some businesses end up
using what is colloquially referred to as “modified cash”
accounting. This isn’t a generally accepted accounting
standard, and it should be avoided.
The advantages to accrual accounting are the match-
ing of income and expense, a correct representation of
net worth on the balance sheet, and an avoidance of
see-saw income tax obligations that frequently result
from cash accounting. A good accountant, who you will
need when you start your business, can easily help you
set up and maintain a set of accrual statements.
One of the most useful things you can do with your
financial statements is to periodically benchmark your-
self against other agencies of similar size and location.
Benchmarking will help you to understand how well