Cash Vs. Accrual Accounting Analysis

November 30, 2022

by a searcher from Carleton College in Burlingame, CA, USA

Hi All,

I am looking to purchase a landscaping maintenance company in California. I was told that their P&L Statements are prepared with the "Cash Accounting" methodology. I know cash accounting becomes an issue when you one is looking to interpret the productivity of the business as well as the true annual and monthly free cash flow.

Does anyone have any advice regarding how I should go about my initial analysis without ordering a QoE report? Is there a particular way I should be reviewing the financials, given that the accounting is currently utilizing the cash accounting principles?

Thank you in advance for your assistance.

-John

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Reply by a searcher
from Ivey Business School at Western University in Toronto, ON, Canada

The biggest item you would want to understand is how cash is received from customers (ie. in advance / at time of service / in arrears). Their statements are based upon when cash is received and may not match when services are performed. Under an "accrual" basis of accounting, they mismatch is removed. Especially in the landscaping industry, you could have clients pay upfront for 3/6/12 months of service. You would want to understand their billing structure and try to marry that to the cash statements received. On the expense side, you'll want to watch out for any future expenses/liabilities that get paid at a future date. You'll want to understand whether there are any unknown bills coming due, post-acquisition. Hope this helps.

Reply by a searcher
from Arizona State University in Traverse City, MI, USA

I'm under LOI with a construction contractor company. They use cash accounting for all of their financial statements. I've hired a CPA to help me with the fin due diligence and she requested the seller run a transaction detail by account report. When I asked the seller that, he responded by saying that's it's an unusual request and I'm not buying the history, it's an asset sale not a stock sale. I'm hoping he just misunderstood the purpose because I didn't really explain why. Any thoughts on why he would balk on sending that? I trust the seller and don't think he is trying to hide things or pad the earnings. But I could be wrong.

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