They didn't teach accrual-based accounting at Harvard. At least not to undergraduates. I had to learn it the hard way.

When I was a college junior, I managed a student linen service: two pressed sheets (those were the days before no- iron sheets), 3 fresh towels, and a pillowcase delivered once a week to your dorm room: $26 a year, all payable in advance. What a deal — we had 5,000 customers and all of the money came in from concerned moms during the summer, before school even started. I figured that my bottom line for the July-September quarter would be fantastic.

Not so.

Lesson #1: You can't book revenue that you haven't earned.

The school year ran for nine months; our revenue was accrued (added up and set aside for the future) during the summer months and then recorded as income over the next nine months. We received $130,000 for our services by September 30 and recorded it on the Balance Sheet as "Unearned Revenue." Then we earned $14,444 ($130,000/9) for each of the nine months starting in September and recorded it on the Income Statement as we delivered our service.

What about all of those start-up marketing and administrative expenses? They were paid out by us in the first three months, as invoiced, but for accounting purposes they were rolled up into a tidy ball called "Prepaid Expenses" and accrued on the Balance Sheet. Like the Unearned Revenue, they were apportioned evenly and charged out as expenses over the next nine months.

Lesson #2: You have to match revenues and expenses to understand and track your economic model.

The next year, my senior year, I managed another business for which cash accounting would have been misleading. We chartered 18 airline flights and sent 2,000 students, faculty, and staff to Europe or home to the West Coast at various intervals during the summer. At ticket prices of $240– 300 a seat, round-trip, we grossed nearly $600,000.

The airlines, of course, wanted their money up front — a healthy deposit, then final payment at least 30 days in advance, recorded as a Prepaid Expense on our books. To fund this working capital requirement, we had to collect our Prepaid Revenue from our passengers well in advance. But none of the Revenue was earned, and none of the chartering Expense incurred, until the flights actually took off in June, July, and August.

So our financial statements looked strange — cash building up on the balance sheet during the school year offset by liability for Deferred Revenue; and then cash going out in big chunks to the airlines offset by an asset called Prepaid Expense. But no revenue appeared on the income statement until the first flights left in June.

Lesson #3: You can go nine (or even eleven) months without booking revenue, but don't let that big cash number fool you into thinking that you're making money.

How did we know we were making money? My full- time secretary and I and the four other students who worked with us tracked it against our budget.

We spread the cost of chartering each plane over a 95% "load factor." Then we added $40 per seat to cover our overhead — salaries, benefits, rent, phones, insurance, marketing, etc. If we sold our budgeted 2,000 seats, we had $80,000 as a "Contribution to Overhead" to cover those expenses. The $80,000 went further in those days (Harvard tuition was $1,520 for my senior year), but even with a reasonable contingency we couldn't have made it without detailed budgeting, careful monthly tracking of overhead, and periodic forecasting.

Lesson #4: If your revenues aren't timed to match your expenses neatly each month, you're flying blind without a 12-month budget.

For every unsold seat short of 2,000, we had to absorb the loss of not only the $40 overhead fee, but also the $200–260 per-seat cost that we had to pay United, Swissair, or BOAC. Conversely, for every seat over 2,000, up to the full 2,200-seat capacity, we brought $240–300 straight to the bottom line.

It was a marketing game, for sure, but it was also an administrative challenge — no cancellations until the flight was full and your replacement had paid in full. All six of us could do the numbers in our heads — what the bottom line looked like each month was important only in the context of where we thought we would be at that point. The 12-month results were critical to the profit-share bonuses that we fully anticipated.

Of the 18 round-trip flights, one was cancelled due to lack of demand, and one went off a few seats short of being full. The other 16 hit the 100% mark, some as early as February or March. It was money in the bank and on the balance sheet, but it wasn't on the income statement until the flights took off.

Lesson #5: In cash- basis accounting, you record revenues when you receive the cash and record expenses when you pay it out. In accrual-basis accounting, you earn your revenue when you deliver your product or service, and in the same period, you incur all of the expense related to delivering that product or service.

When we drew the line on the charter flight business at the end of August, we had proven the economic model. We had cash left over in the bank, and net income on the bottom line, and when we paid off all of our bills, the two came pretty close to matching…

…or at least they did before an accrual for my bonus trip to Europe.