Don’t reinvent wheels. Please. As you do your sales forecast, be aware that accountants and financial analysts have definite meanings for timing of sales. If you don’t deal with this their way, then when you do eventually incorporate the work you’ve already done on the sales forecast into more formal financial projections, you’ll have it wrong. It will look bad.

So What’s Accrual Accounting and Why Does it Matter?
So you make a sale. When you deliver the goods, you record it as a sale. If the customer didn’t pay you immediately, you record the accrued amount as accounts receivable.Then you order some goods. When you receive them, you don’t pay for them. Instead, you record the accrued amount as accounts payable.

At the end of the tax year you have some expenses outstanding, like professional services you know you’ll be billed for in the future. You accrue those expenses into the current tax year. They are deductible against income.

In so-called cash basis accounting, the opposite of accrual accounting, you don’t put the sale or the purchase onto your books until the money changes hands. With business-to-business sales, the norm is that the money changes hands later. So accrual accounting is better. It gives your books a more accurate picture of your financial flow and financial position.

Why does this matter here? Because timing of sales, costs, and expenses makes a difference. Start your forecasts correctly so they can be part of a more formal financial forecast when you finally need one.

Timing of Sales

Your sales are supposed to refer to when the ownership changes hands (for products) or when the service is performed (for services). It isn’t a sale when it is ordered, or promised, or even when it’s contracted. With proper accrual accounting, it is a sale even if it hasn’t been paid for. With so-called cash-based accounting, by the way, it isn’t a sale until it’s paid for. Accrual is better because it gives you a more accurate picture, unless you’re very small and do all your business, both buying and selling, with cash only.

I know that seems simple, but it’s surprising how many people decide to do something different. And the penalty of doing things differently is that then you don’t match the standard, and the bankers, analysts, and investors can’t tell what you meant.

Timing of Costs

Costs of sales or direct costs or costs of goods sold are supposed to be timed to match the sale.

For example, when you buy a book from a bookstore, whatever that book cost the store to purchase was an amount added to inventory until you purchased it, and only then, with the purchase, it became an amount added to cost of goods sold.

Notice the timing. It sits in inventory for as long as it takes, but it doesn’t get out of inventory and turn into cost of sales until it gets sold.

Messing that up can mess up your financial projections. When sales for the month are $25,000 and cost of goods sold are $10,000, you want the $10,000 to be the costs it took to buy whatever was sold for $25,000. If this month’s costs are for things sold last month, or things sold next month, you get bad information.

It’s harder to keep track of this sometimes with services. The cost of sales for a taxi ride should be the gas, the maintenance, and the driver’s compensation. But accountants would go crazy trying to match the exact gasoline costs to the exact trip, so they estimate a lot. They are always trying to match the months though; costs should be recorded in the same months as the corresponding sales.

Timing of Expenses

Expenses are supposed to show up in the month that they happen. Ideally, travel expenses are attributed to the month you travel, even if you paid the airfare two months earlier. Ideally, advertising expenses are recorded for the month that the ad appears in print, rather than the month when you submitted the ad. And they certainly should not appear in the month in which you pay for the ad, which often is two or three months later. You want the timing to match.

Tim BerryTim Berry

Tim Berry is the founder and chairman of Palo Alto Software and Follow him on Twitter @Timberry.