Impact of Accruals on Cash Flow
Accrual basis accounting records revenue once the source transaction is complete, once its numerical value can be calculated and once there is no doubt that the sum can be collected. Furthermore, accrual basis accounting requires revenues to be recorded in the same time periods as the expenses spent to produce them, much as it requires expenses to be recorded in the same time periods as the revenues produced their occurrence. As such, accrual basis accounting requires revenues and expenses to be recorded even when cash and cash equivalents have not been received or paid out.
Cash and Cash Equivalents
Cash and cash equivalents are grouped together on the cash-flow statement. Cash equivalents are certain financial statements with terms of three months or less that can be converted to cash with minimal risk. Cash and cash equivalents are grouped together not only on the cash-flow statement but for most accounting purposes.
Cash flow is a change in the business’ cash and cash equivalents. Cash inflows or cash receipts are increases in cash and cash equivalents, while cash outflows or cash payments are decreases in cash and cash equivalents. Cash flow is quite different from revenues and expenses because revenues and expenses does not need the exchange of cash and cash equivalents to be recorded.
Accrued Revenues and Expenses
Accrued revenues and accrued expenses are revenues and expenses that have occurred but for which the cash and cash equivalents have yet to exchange hands. Since no cash and cash equivalents have exchanged hands, no cash flows have been created. Examples of accrued revenues and accrued expenses include the interest collecting on financial instruments held by the business and the salaries to be paid out to employees.
Impact of Accrued Revenues and Expenses
Accrued revenues and accrued expenses themselves have no impact on cash flow because neither cash nor cash equivalents have exchanged hands. The cash flow for the sums in question do impact the cash flow statement, but they do so as changes in accounts receivable and payable rather than as the accrued revenues and expenses themselves. For example, a business might record $2,000 in accrued interest revenue and the same amount in interest receivable. No cash is received until the interest receivable is collected, at which time it is only indirectly associated with the original accrued revenue.
Alan Li started writing in 2008 and has seen his work published in newsletters written for the Cecil Street Community Centre in Toronto. He is a graduate of the finance program at the University of Toronto with a Bachelor of Commerce and has additional accreditation from the Canadian Securities Institute.