Accrual versus cash

Cash accounting records a transaction when money moves. Accrual accounting records it when the economic event occurs, regardless of when money moves.

Indian company financial statements use accrual. Understanding why — and what it costs — is the hinge of this subject.

Why accrual won

Take a business that signs a ₹1 crore contract in March, delivers in April, and is paid in July.

Under cash accounting it earned nothing in March, nothing in April, and ₹1 crore in July. That is a true record of its bank account and a useless description of its business. The work happened in April; attributing the whole result to July says nothing about whether April was a good month.

Accrual puts the revenue in April, when the service was delivered, and records a receivable until the money arrives. The income statement then describes performance over a period rather than cash timing, which is the only thing that makes year-on-year comparison meaningful.

It also makes a business with lumpy collections readable at all. A company paid once a quarter is not idle for two months out of three.

What it costs

Recognising things before cash moves means profit becomes an opinion about timing. Five of them, every one legitimate and every one a lever:

Accrual	What is being judged
Revenue recognised, not yet collected	Was it earned? (ch 6)
Expense incurred, not yet paid	What is owed but unbilled?
Cash paid, expense not yet incurred	How much belongs to next year?
Cash received, revenue not yet earned	When will we have performed?
Asset consumed over years	Over how many, and in what pattern? (ch 8)

Cash accounting has none of these questions and answers none of the useful ones. Accrual is strictly more informative and strictly more manipulable. That trade is not a flaw in the design; it is the design.

Why a profitable company goes bankrupt

Profit is an accrual concept. Solvency is a cash one. Nothing connects them in the short term.

A company growing fast is the standard case. It recognises revenue when it delivers, pays suppliers and staff in cash, and waits sixty days to be paid. Every rupee of growth widens the gap, because the cash goes out before it comes in. The faster it grows, the worse the squeeze — and the income statement reports it all as success.

That is the mechanism behind chapter 11 of the Company analysis subject on working capital: growth consumes cash, and a business can be profitable, growing and insolvent simultaneously.

Companies do not fail because they are unprofitable. They fail because they run out of cash, and the income statement is not the statement that warns you.

Reading the gap

The four explanations the problem asks for, with ₹50 crore of profit and negative operating cash flow:

Receivables grew. Sales were recognised, cash not collected. Benign if growth is real, serious if collection is deteriorating — and the two look identical for several quarters.

Inventory grew. Cash spent on stock that has not sold. Benign before a launch, serious if it is not moving.

Payables shrank. Suppliers paid faster, perhaps because they demanded it.

Revenue was recognised early. The legitimate version is a genuinely long contract; the aggressive version is chapter 15.

Investigate receivables first, and specifically whether they grew faster than revenue. Revenue up 20% with receivables up 60% is the single most informative ratio in this area, because it says collection is getting worse rather than sales getting better.

Why both statements exist

This is the structural answer to why there are three statements rather than one.

The income statement tells you about performance, using judgement. The cash flow statement tells you about cash, using far less. Ind AS 7 requires the cash flow statement precisely so that the accrual judgements in the income statement can be checked against something harder.

Chapter 14 shows how that statement is actually prepared, and the preparation itself is the reconciliation: it starts at profit and removes every accrual until only cash is left.

The point

Accrual accounting records events when they occur rather than when cash moves, which makes the income statement a description of performance instead of a bank statement. The cost is that profit becomes a set of timing judgements, so a company can be profitable and running out of money at the same time — and growth makes that worse, not better. Receivables growing faster than revenue is the first thing to check.