Why Cash Flow Often Feels Off
A few years ago, I sat down with a contractor I’ll call Mike. He ran a small commercial and residential remodeling business, five crews in the field, and a dozen active projects at any given time. On paper, his books looked solid. Revenue was steady, expenses were under control, and profits seemed reasonable. But when I asked Mike about cash flow, his brow furrowed. “It feels like we’re always behind, even when jobs are going well,” he said.
This is a story I hear over and over. Contractors and small business owners often think the numbers on their reports are the full picture. They’re not. How you account for revenue and expenses fundamentally changes how you see your business, how you plan for taxes, and even how others value your company.
What Cash Basis Accounting Does
Cash basis accounting is the method Mike was using. You record revenue when cash hits the bank and deduct expenses when they’re paid. It’s simple, it’s intuitive, and it has tax benefits, especially for small businesses. You can defer income or accelerate expenses to reduce your taxable income. For a lot of owners, that’s exactly what they need in the short term.
The Hidden Problem
But here’s the catch. Cash basis doesn’t always reflect what’s actually happening in the business. Mike had multiple projects underway. Some invoices were unpaid for weeks. Bills for materials and subcontractors were due at different times. When we reviewed his cash-based statements, they showed uneven profits, swinging wildly month to month. They didn’t match the reality on the job sites.
Why It Matters for Decisions
Financial statements influence decisions, valuations, and access to capital. During periods of growth, revenue can appear lower than it really is because accounts receivable isn’t recorded. Expenses that have been incurred but not yet paid are invisible. This can create a distorted picture for potential buyers or lenders. Accrual accounting, by contrast, matches revenue to the expenses incurred to generate it. It smooths out timing differences, shows the real profitability, and provides a reliable picture of cash needs.
When Mike considered selling a portion of his business, the difference was stark. His cash-based books showed moderate profits and low receivables. After adjusting to accrual, it became clear that the business generated significantly more income than he realized. That adjustment directly impacted the valuation and ultimately the sale price.
Cash Basis and Working Capital
Cash accounting also affects working capital calculations in transactions. Buyers often peg purchase prices based on net working capital at closing. If cash-based accounting understates receivables or payables, the net working capital figure may be off, leading to price adjustments. For Mike, knowing the difference between cash and accrual allowed him to negotiate with confidence and avoid surprises at closing.
How Accrual Accounting Changes the Game
With accrual accounting, revenue is recorded when earned, and expenses when incurred. That $450,000 project appears as accounts receivable. Prepaid expenses are listed as assets. The books now tell the story of Mike’s business accurately.
Accrual accounting smooths out fluctuations in monthly profits, reveals working capital clearly, and provides a reliable measure of ongoing earnings. Buyers and lenders prefer this transparency because it shows consistent performance and reduces uncertainty.
The Impact on Valuation
Once Mike switched to accrual, the business’s normalized earnings increased significantly. It looked larger, more stable, and more predictable. When he eventually went to sell, buyers could see a consistent profit picture, and the working capital aligned with the business’s actual operations. The business commanded a higher price than it would have on cash-based statements.
The Bottom Line
The lesson is simple but critical. Cash basis accounting works and can save taxes, but it doesn’t always reflect economic reality. Understanding the timing of revenue and expenses, recasting financials when necessary, and knowing how your method affects valuations and taxes is essential.
Mike’s story is common. Contractors and small business owners often operate on intuition, looking at cash in the bank, but missing the bigger picture. Accounting is not just a compliance tool. It’s a lens to see your business clearly, make smarter decisions, and capture its real value. The better you understand your books, the better you control your business, your taxes, and your future.
Talking to an Accountant
Whether you're unsure if cash basis is the right fit for your long-term goals or simply want to understand your options better, consulting with a qualified accountant is highly recommended. We can help you determine the best accounting method for your business and ensure your financial reporting accurately reflects your company's health.
.jpg)
