Why Lenders Want Your Accrual Basis Financial Statements

As you prepare your business for the upcoming recession, you will want to evaluate things such as your headcount, pricing, business continuity plans, and cash flow / finances. Specifically addressed here is a discussion about your line of credit. Now is the time to get things like this in order to survive the headwinds.

When applying for a loan or line of credit, your lender will ask for your financial statements. In most cases, they will ask for those to be generated on an Accrual basis, versus a Cash basis.

Many business owners focus only on the cash basis, as they likely file their taxes on a cash basis. Some businesses (such as retail) have no choice, they must file their tax return using accrual basis.  In any case, it is important to maintain a tidy set of books on an accrual basis.

Bankers don’t like surprises. When making a loan they want to know your accounts payable (A/P), how current you are with your creditors, and how well your customers pay you (A/R).

If you maintain your books on an accrual basis, you record (or “accrue”) your A/R and A/P when you deliver goods and services and when you receive supplies or are given trade credit. You may extend terms to your customers or have trade credit extended to you; but as an accrual basis company, you still consider the sale to a customer or purchase from a supplier as complete when the transaction occurs.

In contrast to accrual, many accountants advise using a cash basis, meaning that revenue is recognized when payment is received. Thus, revenue isn’t recorded until the customer pays your invoice, and expenses don’t get recorded until the business pays its bills.

Cash basis financial statements are deficient; lenders want to see the entire picture.

If your books are maintained on a cash basis only, the financial statements you furnish your lender will not report the correct A/R or A/P on the balance sheet. If they don’t, then you should print a copy of your Accounts Receivable Aging and your Accounts Payable Aging reports at the same time. These reports should have the same date as the Balance Sheet and Profit & Loss Statement.

QuickBooks and other accounting software for small business often have the ability to generate a report on an accrual or cash basis format. If you are furnishing reports to your banker, make sure you select accrual for the report format. Also make sure your complete A/R and A/P is shown on the aging reports.

Below is a short list of other surprises you should avoid when applying for credit:

  • If there is a receivable on your A/R aging report that you don’t believe you will be paid for, add a separate page indicating which accounts are “doubtful” and give the reason. An accrual basis company should have a separate contra account on the balance sheet indicating the amount of all doubtful accounts.
  • If you do show A/R and A/P on your balance sheet, make sure it has the same total as on the A/R and A/P aging report. This seems basic but we have seen unmatched reports many times.

The issue you want to avoid is having the lender see one or two errors or balances that don’t match to other reports where they should.  Or worse yet, you don’t want to release financial statements that don’t make sense (with negative numbers, Open Balance Equity balances, etc.).  When lenders receive reports, they tend to doubt the accuracy of the entire set of financial statements.

Soon we will be headed to a tough credit environment. Having financial statements that make sense, will help keep you from being turned down for credit. If you need help getting your books in order, give us a call. We specialize in small business and will get your books in ship-shape for your lender.

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