Converting Accrual Financial Statements Into Cash Flow
Financial statements prepared on an accrual basis will recognize all financial transactions regardless of the collection of cash at the point of sale or the payment of costs and expenses at the time the costs and expenses are incurred. The advantage of the accrual method is that the user will see all the accounting transactions in a given period, thus providing the opportunity to perform a thorough analysis of the entity. The disadvantage is that the accrual method does not indicate the amount of cash generated or used by the entity.
Financial statements prepared on the cash basis will recognize financial transactions when cash is collected from sales and paid out for costs and expenses. It is meant to present a more conservative view of an entity’s performance by ignoring transactions that do not generate cash or use cash. Since the cash basis only reflects cash transactions, there is no need to perform a cash flow analysis because the financial statements are on a cash basis already. The disadvantage is that the user of the financial statements will not see all the financial transactions an entity experienced over a time period.
So, what type of financial transaction should loan officers obtain? The answer is financial statements prepared on the accrual basis because it will reflect all financial transactions. Even though accrual financial statements do not display how much cash is generated or used over a period of time, it is best to obtain it because they can be converted into a cash basis financial statement, and that conversion process is cash flow analysis, which is the purpose of this course.
