Understanding When Cash Isn’t Revenue – and When Revenue Isn’t Cash
This is Part II of a three-part series:
– Part I: GAAP Basics
– Part II: Understanding Margins
– Part III: Cash vs. Revenue (you are here)
A Quick Reminder on Why We’re Using GAAP Terms
Throughout this series, I’ve been intentional about using GAAP terminology.
GAAP — Generally Accepted Accounting Principles — gives business owners a shared, accurate financial language. It prevents misinterpretation, reduces risk, and ensures your books tell the truth.
Using correct GAAP terms gives you:
- Clarity — you know what numbers truly represent.
- Consistency — everyone’s speaking the same language.
- Credibility — with lenders, accountants, and buyers.
Financial accuracy begins with financial vocabulary — and in this last part, you’ll see exactly why that matters.
For Advisors: This series uses strict GAAP terminology to give your clients a shared financial vocabulary. Feel free to share these articles before planning meetings to align on foundational concepts.
Opening
Many small-business owners misclassify money the moment it hits the bank.
One of the most common — and costly — mistakes is treating customer deposits as revenue.
Under GAAP, customer deposits are not revenue.
They’re liabilities.
Misclassifying them distorts your financial statements, inflates your top line, and creates a false sense of profitability — especially in project-based or service-based businesses.
Let’s return to Craig Gilmore, owner of Craig’s Cleaners in Santa Ana.
Craig’s Example
A corporate client pre-pays $2,000 in early March for dry-cleaning services to be performed over the next month.
Craig deposits the check and sees cash increase. But under GAAP, that $2,000 is not yet revenue.
Why? Because the service hasn’t been performed.
Until the work is delivered, that money is a liability — classified as Unearned Revenue or Customer Deposits on the Balance Sheet.
Correct GAAP Classification
| Item | GAAP Classification | Financial Statement |
|---|---|---|
| Customer deposit (before work is performed) | Liability — “Unearned Revenue” or “Customer Deposits” | Balance Sheet |
| Revenue (when earned) | Revenue | Income Statement |
Cash vs. Accrual: The Timing Difference
Under cash-basis accounting, Craig would record that $2,000 as revenue immediately — because cash was received.
Under accrual-basis accounting (required for GAAP), Craig recognizes revenue only when it’s earned.
As each week’s cleaning is completed, the liability decreases, and the earned portion becomes Revenue on the Income Statement.
This reflects GAAP’s matching principle — aligning revenues with the expenses incurred to generate them.
Why Misclassifying Deposits Is a Problem
- Inflated Revenue — Books look stronger than reality.
- Distorted Margins — Costs haven’t hit yet, margins appear better than they are.
- Inaccurate Cash Planning — Cash ≠ Profit. Spending deposits prematurely drains liquidity.
- Tax Complications — You may pay taxes on unearned income.
- Misleading Financial Ratios — Working capital and current ratios become unreliable.
A Simple Journal Example
Client pays $10,000 deposit for next month’s project.
Incorrect (non-GAAP) entry:
Credit Revenue $10,000
Correct GAAP entry:
Debit Cash $10,000
Credit Customer Deposits (Liability) $10,000
When work is completed:
Debit Customer Deposits $10,000
Credit Revenue $10,000
Now the books tell the truth:
- Cash increased ✅
- Profit did not increase yet ✅
- Work is still owed ✅
That’s the purpose of GAAP — to keep you honest, even when cash feels like profit.
Conclusion
Customer deposits feel like revenue.
They look like revenue.
They spend like revenue.
But under GAAP — and in financial reality — they’re liabilities.
Understanding this distinction protects you from:
- Overstated revenue
- Distorted margins
- Tax risk
- Operational blind spots
Financial literacy isn’t theory — it’s protection.
When you use GAAP language, you see your business the way professionals do.
And that clarity separates owners who run books from those who run businesses.
Series Conclusion
These three articles covered the foundation of financial literacy:
Part I: The Language — Revenue, COGS, Gross Profit, Operating Income, Net Income
Part II: The Analysis — Gross Margin, Operating Margin, Net Margin, Contribution Margin, Margin Mix
Part III: The Timing — Cash vs. Accrual, Deposits as Liabilities, Receivables as Timing Gaps
Master these concepts, and you’ll make better decisions than 80% of small business owners.
Your numbers will finally tell you the truth — and you’ll know what to do about it.