From: <insert your name>, Senior Accountant
Re: Reason for the Delayed Wage Payments
I’m writing a memorandum to address the issue of the delayed payment of employee’s monthly salary and to clarify the difference between cash and accrual accounting method that the company has adopted. Cash and accrual accounting are two methods applied by various businesses to account for their cash flow. The methods differ from one another: in the accrual accounting, the business revenues and expenses are recorded regardless of when the money is received or paid; while cash accounting recognizes revenue when cash is received, or the expenses are paid. We have used the method of cash accounting to prioritize payment of our equipment suppliers and other crucial bills that sustain our day to day running as an organization to ensure its continued existence.
On the other hand,we are mostly using accrual accounting by ensuring that we finance our client’s services for six months without pay to encourage them to hire us. This act of giving credit serves the aim of attracting as well as retaining customers. Finally, we as a company had to pay upfront for two years of insurance coverage. These are the reason why we have fallen short on our cash inflows, therefore, leading to delay in payment of the salaries to employees.
The accounting team prefers to apply to the accrual accounting method because it can accurately track the long-term performance and also be able to approximate our future income and expenses. By offering our customers financial support for a period of six months, we shall be able to encourage them to hire our services. Also, we shall be able to pay for our insurance coverage for two years. However, accrual accounting does not accurately represent cash flows. For instance, your profit may seem positive, but in a real sense, there is nothing in the bank account. These can be solved by ensuring that the company can provide separate financial reporting and analysis for cash flow when using this accounting method.
During the end of the year, the company has reported a positive net income because the company’s clients who have been entirely financed for six months shall prefer to hire much more services from us, and hence we shall receive their payments at the end of the mentioned period. These shall result in a shortfall of cash flow because there is no payment being received from these clients at the current moment and also because we are paying our suppliers based on the delivery of products.
The company can have a positive net income yet experience a cash flow shortfall. This situation is resulted from the fact we are recording income when we earn it and do not record the cash when we receive if because of cash outflow through financing our clients for six months, paying for an upfront insurance cover, and also we are paying our equipment suppliers on pay on delivery basis.
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