Cash? Accrual? What the Heck?
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This is the second episode in our Financial Basics for Authors series. In this episode, I talk about the two different ways used to account for your business activity: Cash basis or accrual basis. I explain what each one is, and which one is best for an indie author’s business.
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Transcript – Episode 12
Hey, fellow indie authors, welcome to this week’s episode of the Indie Author Biz Guide Podcast. This is the second episode of our Financial Basics for Authors Series, and in this episode I talk about the two different ways to account for your business activity cash basis or accrual basis. I explain what each one is and which one is best for an indie author business.
Welcome to the Indie Author Biz Guide Podcast. I’m Tora Moon, genre bending fantasy and sci fi author, indie business author, and entrepreneur. Here we talk about the business of self-publishing, or as I prefer to call it, indie publishing. As an indie author, you have entered the wonderful world of entrepreneurship. On this show, I guide you through the rocky waters of the indie publishing industry.
I share business basics and principles you can apply to your author business, really, any business. Other indie authors share their experiences and expertise to give you insight in your career and build your business. You can download your free indie author business checklist, find additional resources, and the show notes at Indie Author Biz Guide dot com. And now here’s today’s episode.
The Two Methods of Accounting
Cash? Accrual? What the heck are those?
Accounting has two methods to account for transactions. Cash basis and accrual basis. The main difference between the two is the difference in timing. They still record your income and your expenses, but it’s when those income and expenses are recorded that makes a big difference.
In some businesses, it doesn’t matter whether you use cash or accrual basis because you’re getting your money the same month that you sell it [your product].
However, that is not the case for the publishing industry. Unless you are selling directly on your website, then you are rarely getting money in the same month that you made the sale. And that is going to make a big difference in how you account for your sales and how you make business decisions on your sales.
Method 1: The Cash Basis
For the cash basis, that means that you are recording all of your transactions based on when your cash goes out or when your cash comes in. Kind of easy.
For an example of this, most people keep track of their money, their personal money, on a cash basis. They know when their paycheck comes in and they pay their bills. They’re looking at their bank account or their check register, or if you’re a nerd like I am, you do your accounting on QuickBooks. But you’re keeping track of when your paycheck comes in and when you pay your bills.
Well, quite often you didn’t make or earn the money that you received on your paycheck in the same month that you’ve received it. Quite often you actually worked in the prior month and earned that income in that prior month. But you’re getting paid like two weeks later or a month later for the previous months work. Say we’re at the end of January, and you work two weeks at the end of January, but you’re not getting that paycheck until February. Cash basis doesn’t matter. You’re just going to record that you received that in February.
If you are in a retail business, it doesn’t matter because you’re receiving the cash when you make the sale concurrently.
You go to your favorite store, you go to Joanne’s or Michael’s or Barnes and Noble, and you buy a book or you buy some fabric or whatever. You pay for it immediately. That store earned that money right then and there. Most often, that type of a store are recording their sales on a cash basis.
The same thing with your expense. For your personal expenses, you’re paying your utility bill and you’re counting that you paid it in February. Well, when you look at your utility bill, that’s actually for the electricity that you used in January.
Hopefully, this is giving you an idea of there’s a timing difference between when you actually earned the money or incurred the expense and when you pay it.
In cash basis, you don’t care about that. You just care about booking it and recording it when you receive it or when you pay it.
Method 2: The Accrual Basis
For accrual basis, what you do is you match and record your sales and your expenses in the month that you earned them or incurred them. And that sounds kind of complicated, but really it isn’t, especially if you use an accounting software system.
In our industry of the book publishing industry, it’s almost imperative that you use the accrual system because we do not receive the money for our sales in the month that we make them.
All of the platforms, if you’re using Amazon or Kobo, Ingram Spark, Draft to Digital, all of them pay 60 days after the sale. That means that the sales that you make in January you aren’t receiving until March.
If you record that on cash basis, then you’re always going to have to be doing mental gymnastics to figure out what your January sales really were.
Because what you received in March and you record for March are not your March sales. They’re your January sales. And that can make a big difference in how you make your business decisions.
When you record a sale on a cash basis, your entry,(if you want to know the technical accounting entries,) is you on one side, you record it to your sales, and the corresponding balancing side is cash.
However, when you are accrual basis, what happens is you record it to sales, “Okay, I had X number of dollars in January of sales.” I’m recording those sales in January, but I haven’t received that cash yet so I can’t record it to cash. So the other side of that entry is accounts receivable because Amazon, Kobo, Draft to Digital, whatever platform that you made that sale on owes you that money, so you have a receivable.
When you receive that money, then you take it out of your receivable and put it into your cash. Not really difficult if you’re using an accounting system.
For expenses, quite often we incur expenses, but we don’t pay them immediately. An example for expenses is you book an editor, they send you an invoice. They may give you 30 days to pay on that invoice.
On a cash basis system, you would record that expense the day that you pay the invoice. So I got the invoice on February 1st, I’m not paying it till March 5th. I would record, on cash basis, that editing expense in March when I paid it.
However, on accrual basis, that expense was actually incurred in February. So you would record it in February and your offsetting account rather than cash is accounts payable. You owe that money to your editor. When you pay it, you take it out of accounts payable and you take it out of your cash.
The Accounting Standard
The accrual basis is the accounting standard. If you were trying to do your accounting under Generally Accepted Accounting Principles, in accounting terms that’s called gap–GAAP, you would need to do accrual basis. And the reason that it’s generally accepted is because it’s a better matching of your income and expenses to the period they actually apply to.
Problems Caused by Using the Cash Basis
In our business, if we use the cash basis, what it does is create a 60 day mismatch of our income especially, and it may also our expenses, but mostly in our income. And that’s where it makes a huge difference.
If you are recording and keeping track of your sales based on when you get the cash, one of the biggest problems that it creates, it’s gives you false data that you’re looking at.
For instance, you make your sale in March, but you don’t record it until May when you received the cash. You’re down the road, you’re looking at planning your next year. You look at your financial statements and you go, “Oh, May had really good sales. Yeah, there was this blip in May. That’s a good time for me to launch my new book because May had really good sales.”
But this is a false assumption if you’ve done your books on cash basis.
So you do your big launch in May and it doesn’t do as well as you thought it would do based on your past track record. That’s because your May booking was for March, really, you should have launched in March because that was your better month, not May.
If you were using the accrual basis and recording your sales in the month that they occurred, you wouldn’t have this problem.
You’d be able to look at your sales, your trend data on your financial statements, (and that’s one of the reasons you have financial statements; it gives you that trend data,) so you can see your ups and downs and where things are over time. If you use the accrual basis, then you could look at it and go, “Oh, my March sales were really good. My May…eh… I’m going to release this new book in March.”
And you’re more likely to have a better launch because you have this data that your sales tend to do better in March than they do in May. You don’t have to do any mental gymnastics of saying, “Oh, wait a minute, these May numbers, those really aren’t May. I really didn’t sell them in May. I really sold them in March. So I need to do those mental gymnastics and figure out what I need to do.”
Now, it’s a whole lot easier just to look at your trend data and not have to say, “Oh, that’s 60 days. Got this 60 day difference.” And another problem with recording on a cash basis rather than an accrual basis that causes in our industry, is now you have a mismatch in determining your cost of sales.
If you’ve recorded on a cash basis, and you are looking at your March advertising expenses and your March sales, and you’re on cash basis, you’re going to have the wrong assumption that your advertising generated X dollars of sales. It didn’t. Your March advertising is actually going to be affecting what your May sales were. You’ve got this 60 day difference.
However, if you were booking accrual basis, you could look at your March sales and your March advertising expenses and be able to tell, “oh, these expenses helped me generate X number of dollars. I have this return on investment on this advertising expense.” This is not taking into account additional factors such as read through. Which your advertising is not just on your first book or with the book that you’re advertising, you also have a return on investment on your read through, which other businesses don’t have this kind of problem.
Advantage of Using the Accrual Basis Method
When you’re doing your [accounting on] accrual basis, then you’re better able to match and make decisions based on the right timing. Accrual basis sounds complicated. It feels like intuitively it’d be much easier just to keep track of your sales and your income on an Excel spreadsheet when you receive it, when you pay it.
For most businesses, yeah, that works. For our business, not so much because we have this mistiming of when we make the sale and when we receive the money.
How to Use the Accrual Basis
What you do on an accrual system, is every month at the end of the month, you know on the first week or so in the next month, you download your monthly sales reports from wherever you’ve sold books.
We’re in the first part of February when I’m recording this. I would download my January sales reports and record those in January. Then, and because I have now have a receivable, when I do my bank reconciliation in March, when I receive the cash for these sales, then I’m going to remove that amount from my accounts receivable and put it into my cash. I received that cash.
My sales haven’t been touched. I have the correct amount of sales that I made in January recorded in January. All accounting systems have an option for cash or accrual basis. And if you don’t understand it, and you want to use this system, ask an accountant to help you. It will cost you less to pay for an accountant every month than it will to make bad decisions based on erroneous data and making false assumptions.
Now, I don’t do accounting, so this is not a push for accounting. This is letting you know what the standard is.
The Reasons the Accrual Basis Method is Better for Our Business
If you want to be treating your writing professionally, as a professional business, then using the accrual basis of accounting is what you should be doing.
It gives you better data. You don’t have to do any mental gymnastics about when your sales actually occurred. You can tell your cost of sales much better and it gives you a better reflection on what your actual income or loss is for each month.
When you are booking cash basis, you really don’t know how things are lining up because of that 60 day mismatch.
I talk about accrual and cash basis and the differences in my book, Business and Accounting for Authors. So if you need more information on that, I suggest buying the book. It’s available on my website in print, e-book, or audiobook. It’s available on all of the platforms. Or you could ask your library to order it for you. It’s available in the library systems.
New Coaching Service to Help You in Your Author Business
And if you need personal help, not necessarily with accounting, because I don’t do accounting, but if you need personal help with setting up your business, getting your business plan put together, deciding where you’re going to distribute.
Even if you’ve been in business for a while and you don’t have a plan, guess what? You’re flying by the seat of your pants. That works in writing but it can be disastrous for your business.
I now offer author business coaching, which helps you look at your business. Are you set up for success in your business? Do you have your plans in place? Do you know what you’re going to do? If your TikTok videos take off, do you have the foundation set so that you can handle that? That’s part of what we look at in the Author Business Coaching plan. You can find that on my website at Indie Author Biz Guide dot com forward slash ABC.
I hope this has helped you in your business and got you to thinking. Which way is really better to record my sales and my income and am I making decisions based on false data?
Next Episode’s Topic
I hope to see you on the next episode where we continue the Financial Basics for Authors Series and we’ll be talking about your income statement. And this is the statement that shows you what your income and expenses are. Hope to see you then, and I hope you have an awesome, amazing day.
Thanks for listening to this episode of the Indie Author Biz Guide podcast. I hope you found value in it. You can get your free business checklist, find more information, and any downloads mentioned at Indie Author Biz Guide dot com forward slash podcast.
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Thank you, and I hope you have an amazing day!