From accounting standard-setting, set out in the Financial Accounting Standards Board's Statement of Financial Accounting Concepts No. 1 (1978), with the gap read for warning signs by Howard M. Schilit (Financial Shenanigans, 1993).
Compares when cash actually moves with when revenue and costs are booked, and treats the gap between the two as the first place to look for trouble.
When to reach for it
When reported profit and the bank balance tell different stories, as in diligence, a startup's runway, or a business that looks profitable but is short of cash.
How it runs
- Decide the question: profitability, survival, or long-term value.
- Set net income beside cash from operations.
- Find where accruals did not turn into cash.
- Trace the cause: receivables, inventory, capitalized costs, or deferrals.
- Track the gap over several periods.
- Investigate any gap that persists or grows.
Where it sits in SOLVE eX
Go to the source
- Statement of Financial Accounting Concepts No. 1: Objectives of Financial Reporting by Business Enterprises, Financial Accounting Standards Board, 1978
- Financial Shenanigans: How to Detect Accounting Gimmicks and Fraud in Financial Reports, 1993