How Does Net Cash Accrual impact the Working Capital?
This is a conceptual question but often people get perplexed and instead of logically thinking about the concept they try to find the formula for Net Cash Accrual. So get the concepts cleared first!
Two Accounting Method: Cash and Cash Accrual Method
Small firms and businesses mostly follow Cash Method i.e. recording every transaction in cash when the transaction actually happens.
EXAMPLE: Anita sells a furniture in the month of March and amount received in April. In her books, she will record cash received in the month of April. It will show income in April even if no Sale happened and no income in the month of March even after the sales
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In cash method, non-cash items like Depreciation, Goodwill etc are not accounted for. Also, prepaid expenses or losses cannot be amortised over the period of time i.e. if B buys stationery worth Rs.10,000/- for the whole year or more, it will show Rs.10,000 in 1 month and not distribute the amount over different months.
On the other hand in Cash Accrual Method,
– timely depreciation is shown
– Prepaid expenses or losses can be amortised. Eg: Every month Rs.1000 can be shown in the expenses
– Bills payable or receivable are shown when the credit purchase or sale happens and not wait for the actual transaction (i.e. the date of receiving or paying the amount). So if the sale happens in March, it is taxable in the previous year even if amount is received in April
So choosing either of the method will give you different profit and different presentation of your cash flow amounts.
Net Cash Accrual Method not only shows how much Sale actually happened but also the Cash in Bank, Receivables and Payables, Non-cash Items like Pre-paid Expenses (which can be monthly written off)
So over all it shows a detailed picture of Working Capital and WC will increase if all the positive balances are added.
Hope this article helped you.
-D.V.P
FinancialDoodle 