Cash-to-accrual conversion, explained simply
Many smaller companies keep their books on a cash basis. Timing of collections and payments then makes one month look strong and the next weak irrespective of work performed. Diligence converts to accrual so that months and years are comparable.
The conversion needs bank statements, invoices issued and received, and month-end lists of unpaid amounts.
December: cash basis and accrual basis
IllustrativeRiverbend HVAC Services, $ thousands
On a cash basis December looks weak. On an accrual basis it was a strong month.
Calculation
FormulaAccrual revenue = cash received − opening receivables + closing receivables
FormulaAccrual expenses = cash paid − opening payables + closing payables
Worked example
| Riverbend HVAC, December, $ thousands | Revenue | Expenses | Profit |
|---|---|---|---|
| Cash basis | 95 | (70) | 25 |
| Less: collected for November jobs | (20) | ||
| Add: December jobs not yet paid | 35 | ||
| Less: November bills paid in December | 10 | ||
| Add: December bills not yet paid | (12) | ||
| Accrual basis | 110 | (72) | 38 |
Riverbend HVAC Services is a fictional company. All figures are illustrative.
Why it matters in a deal
Price, working capital targets and trend analysis all depend on accrual-basis figures. Cash-basis results can hide growth, decline or period-end timing.
Red flags
- Owners delaying payments or accelerating collections ahead of a sale
- Missing or incomplete receivable and payable records
- Large unexplained differences between cash-basis and accrual-basis results
Frequently asked questions
What is cash-to-accrual conversion in M&A?
Cash-to-accrual conversion restates financial results kept on a cash basis, where income and costs are recorded when money moves, to the accrual basis, where they are recorded when earned or incurred.
Must small businesses use accrual accounting?
Not always for tax purposes, but buyers and lenders usually require accrual-basis numbers.
What records are needed?
Bank statements, invoices issued and received, and month-end schedules of unpaid amounts.