Amount and Timing

Quick reference

• 00:02 Hi, I'm Ray Sheen.
• 00:06 I'd like to talk with you about two fundamental elements of business financial
• 00:11 transactions.
• 00:12 That is amount and timing.
• 00:14 These two essential attributes are how we characterize a financial transaction.
• 00:20 Let's discuss those two aspects.
• 00:21 They have a major implication for financial reporting,
• 00:24 because of the time dependency associated with financial reports.
• 00:29 The first thing to understand is that they are equally important.
• 00:32 The date is just as important as the amount.
• 00:34 By amount, I mean the actually monetary value of the transaction.
• 00:38 This is normally expressed in terms of dollars, Euros, Yen, Rupees, Pesos,
• 00:42 whatever currency you're operating with.
• 00:44 The timing is the date on which the transaction occurs.
• 00:48 In financial reporting, the date is just as important as the amount.
• 00:52 That's because financial reports and financial statements are time based.
• 00:56 They're either for a period of time, or prepared for a particular date.
• 01:00 So, depending upon the date of the transaction, it may or
• 01:03 may not be included within the report.
• 01:05 Managers will often find it's easier to manage the date of a transaction
• 01:09 than the amount.
• 01:11 Since it's so important that we manage the timing of transactions,
• 01:14 we need to understand how the date for transaction is set.
• 01:17 Is it when we agree to the transaction?
• 01:19 Is it when we get control of what we are buying, or
• 01:22 lose control of what we are selling?
• 01:24 Is it when the bill is paid?
• 01:25 Granted, sometimes these are the same date, but
• 01:28 many times in business they are not.
• 01:30 We need to be clear which of these dates we are to use.
• 01:33 There are two methods that can be used to set the timing.
• 01:36 One of these methods is the cash basis, and the other is the accrual basis.
• 01:41 The cash basis sets the date based on when money changes hands.
• 01:44 This is the normal approach of a typical consumer who is out shopping.
• 01:48 The transaction occurs when I go to the store, select a pair of shoes, and pay for
• 01:52 them in the store.
• 01:54 Likewise, when I fill up my car with fuel, I pay the attendant, and
• 01:57 that is the date of the transaction.
• 01:59 The other method is the accrual method.
• 02:02 In this approach the date used for
• 02:03 the transaction is the date when the legal title or control of an item occurs.
• 02:07 The transaction date is based upon gaining or losing control.
• 02:11 For instance, when purchasing, is when a buyer gets access to the material
• 02:15 that the supplier's providing, or receives the benefit of the supplier's work.
• 02:19 It's not when they pay the bill.
• 02:21 The bill may not be paid for another 30 days, but the buyer has control of
• 02:25 the material, so the financial records would record it as a purchase.
• 02:29 Likewise for selling.
• 02:30 The date used in the accrual method,
• 02:32 is when the seller ships the product to the customer.
• 02:35 At that time the seller no longer has control, the customer does.
• 02:39 As you can imagine the difference in dates can have a significant impact.
• 02:43 If the customer doesn't pay for 30, 60 or
• 02:45 90 days, the transaction could be recorded in different quarters, or
• 02:49 possibly even different years, depending upon which method you use.
• 02:54 So under what conditions would we use the cash basis?
• 02:57 The cash basis is going to provide a clearer understanding of how much money
• 03:00 a company actually has available.
• 03:02 It focuses on the liquidity of the business.
• 03:05 This approach is often used by small family businesses or retail operations.
• 03:10 The management determines what they can and
• 03:12 can't do based upon how much cash is in the cash register.
• 03:16 Every night at the end of the work day, they add everything up.
• 03:19 What they sold, and what they spent that day, and then decide whether they're going
• 03:23 out for steak dinner, or going home for mac and cheese from a box.
• 03:26 So why would a business use the accrual method?
• 03:29 Because it is normally a better indication of how well the business is running.
• 03:33 The accrual basis will match benefits with costs.
• 03:37 The business receives raw material during a month.
• 03:39 Employs a workforce to make a product with that material during the same month, and
• 03:43 then sells the product at the end of the month.
• 03:45 The accrual method shows how profitable those efforts were.
• 03:49 Without the accrual method, the financial records could easily show
• 03:53 that the company has lost a lot of money in one month, if they paid for
• 03:56 materials and labor but did not get the benefit of the sale.
• 03:59 At the same time, it could show a tremendous profit if it recorded the sale
• 04:03 and did not pay the suppliers.
• 04:05 The company's records could become badly skewed by one or two late payments.
• 04:10 There are numerous reasons why payments do not happen at the time of the transfer
• 04:13 of the physical control of an an asset.
• 04:15 Especially if you're doing business internationally.
• 04:17 The accrual method is immune to all of them.
• 04:20 Whether it's a delay paying a supplier, or delay in receipt of the payment from
• 04:24 the customer, the accrual method still allows the company to line the costs and
• 04:29 benefits for their activities.
• 04:31 The accrual basis provides a much truer and
• 04:33 clear picture of the profitability of the business activity.
• 04:37 For that reason almost all major corporations use the accrual method.
• 04:42 So let's quickly review.
• 04:44 Every financial transaction has two equally important attributes,
• 04:49 amount and timing.
• 04:50 It is the timing which determines whether or
• 04:52 not a transaction should be included within the financial reports.
• 04:56 Most companies use the accrual method for setting the timing.
• 05:00 That means timing is based upon when control transfers,
• 05:04 not when money transfers.

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