BizCon, a Consulting Firm
Scenario: BizCon, a consulting firm, has just completed its first year of operations. The company’s sales growth was explosive. To encourage clients to hire its services, BizCon offered 180-day financing – meaning its largest customers do not pay for nearly 6 months. Because BizCon is a new company, its equipment suppliers insist on being paid cash on delivery. Also, it had to pay up front for 2 years of insurance. At the end of the year, BizCon owed employees for one full month of salaries, but due to a cash shortfall, it promised to pay them the first week of next year.
As the senior accountant, the Chief Financial Officer has asked you to prepare a memo to be sent to management notifying them of the delayed wage payments.
Prepare the memo in a maximum 700 words including the following information to better outline the situation:
BizCon will use two accounting methods. These accounting methods are cash and accrual basis. Cash basis is used by small business and personal finances. Cash method are mainly usedfor profits when money is received in cash and for expenses when the money is paid out to our suppliers.Cash could be used also for small financial operations and for daily accounting activities. Accrual basis is revenue when it is produced expenses goods and services it is incurred. Reading the scenario, BizCon’s equipment suppliers prefer to be paid in cash and not in credit or in any other type of payment on deliveries. BizCon’s is recording cash for the purchase of goods, services, and products. The proper accrual method shows that BizCon does not pay cash when it has customers. In contrary, BizCon pays in other type of payment, such as; checks or credit when it needs to recorded the transaction for immediate pay item in accounts receivable until the payment has been received. BizCon willpurchase supplies for the month of August on credit, the line of credit will be extended and this would be used as an accrual method in a business expense.
- Explain how cash and accrual accounting differs for each of the events listed in the above scenario and describe the proper accrual accounting.
Assess how at the end of the year, BizCon reported a favorable net income, yet the company’s management is concerned because the company is very short of cash. Explain to management how BizCon could have positive net income and yet run out of cash.
As we all know, BizCon is one of the largest consulting firm. However, their accounting methods are questionable, we have doubts on its distribution in cash and placement of processes. BizCon has two accounting methods, these are cash method and accrual accounting. Today,Larger companies and organizations have the benefit for special financing of 180-day with a non-payment whatsoever of its obligations until the period expired. In some cases, larger companies find an excellent deal doing this type of transaction. On the other hand, there are companies and businesses that prefer to pay in cash its obligations as they solve the financial deficit and other obligations with suppliers. From other perspective, the line of credit will increase the possibility of purchase more items and will generate option to the business on how to payback its obligations. This offer could only be full fill by those big organizations that have reputation and have the possibility to respond with assets and equity. It would be more understandable to offer the benefit of paying cash and not credit to smaller companies because it would accumulate more credibility over the time.Therefore, it will have more sense to offer special financing to larger companies who are paying BizCon on a regular time basis period.
BizCon is an organizationthat have done remarkably well in the first year. However, the company is subjected to pay the supplier in form of cash payment because the line of credit is not significant yet. The company should consider also to pay its employees, the business expenses, and the business associates, so it should generate enough cash to cover all its obligations. Looking at this from an accounting aspect an example is the cash-flow for a certain period = cash in ($1000 cash services) less cash out ($2000 cash paid out to a supplier) = -$1000 cash-flow in the financial reporting period. Which is a negative cash flow result. The explanation of why BizCon has a positive net income and negative cash flow is because the company paid off the insurance for the period of two years. The company has paid $350,000 for two years of insurance, accounting guidelines only allow BizCon to claim a small portion of the insurance expense every year, BizCon paid $350,000 in cash today for two years of future coverage. While the company’s CPA must report corporate income, which may be taxable of $125,000 first year, the company has a negative cash flow for the year of $250,000 (350,000-250,000). Therefore, the business may run out of cash to keep the business afloat, even if it is making revenue.