Kim Havens is a friend of yours from high school. She decided to become a beauti
ID: 2498819 • Letter: K
Question
Kim Havens is a friend of yours from high school. She decided to become a beautician after leaving high school. She recently opened her own shop, and has contracted her services to a local hospital. She is paid a monthly fee for her services, and receives a small gratuity from each of the patients.She has just received her first set of financial statements from her accountant.She is quite upset.The statements show a cash balance of $3,600 at the end of the month, but a net income of only $500.She has written you a letter, asking you whether such a situation is possible, or whether she should find another accountant.Required:Write a short letter to your friend. Use proper form. Answer her question completely, but briefly.
Explanation / Answer
Address: XYZ
14.12.2015
Dear Kim,
How are you.Hows your shop running. In the last letter yoy mentioned that there is difference in your month end net income and cash flow. There can be difference between net income and cash flow due to rthe basis of accounting.
Net income is revenue recognized in a period less the expenses during that period on the accural basis of accounting.So revenue and expenses are related with same period. So we accrue the expenses to recognize the expenses for the particular period, it is not important that the cash payments are made than only we take the expense in the books infact we have to recognize them to the related period.Now there can be prepaid expense i.e expenses paid in advance for next period so we dont deduct it from our income, we show these as assets.Now if we talk about sales these are recognised as they are earned no matter that this is received in cash or not. And if some revenue is received in cash for the sales/services which are not earned than these are excluded from the income and included in liability. Whereas the cash inflow or outfow is the amount received and paid in the reporting period. It does not follow accrual sysytem of accounting lets say prepaid expenses were paid by us in the reporting period so there will be cash outflow but this wont be recorded in Income statement. There can be few non cash expense like depreciation which reduces net income but does not affect cash balance. Net cash flow is calculated by determining changes in ending cash balances from period to period.It is change in the amount of cash.
I hope you will be clear about your doubt regarding difference in net income and end cash balance after reading this letter, so there is no need to change the accoutant.Take care
Your Friend
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