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Thursday, April 3, 2014

Accounting Primer - Cash vs. Accrual Accounting for Film Distributors / Studios

Greetings HHSE Friends - Although this issue should be obvious to most - and although we've addressed it several times in the past to "'splain it to Lucy" and others - we still occasionally get emails or inquiries about how Hannover House (and other film distributors) account for sales, revenues and profits.

There are two principal methodologies for recording revenues under the "Generally Accepted Accounting Principles" as practiced by the major USA accounting and audit firms. 

1).  CASH ACCOUNTING is the way that most individuals or small businesses "account" for revenues.  For instance, if you operated a "COFFEE SHOP" (as an absurd example), you would likely record all of your $1 sales of coffee on a "cash" basis, then deduct all of your direct costs of supplies and operations to determine your "pre-tax income."  That sort of cash-basis accounting is perfectly fine for small businesses and individuals who don't have significant "contracts receivable" for substantial amounts due to the business in the future.

2).  ACCRUAL ACCOUNTING is the way that most manufacturing businesses, video distributors or larger entities with "contract receivables" account for their activities.  For instance, when Hannover House licenses a movie (such as "All's Faire In Love") to Netflix for subscription streaming... their contract payment of $250,000 is made to Hannover House through twelve (12) equal quarterly installments (e.g., the payments are spread out over the 3-year license period for the title's initial subscription rights sale).  Hannover House will "recognize" this sale as it happens... then slowly collect the revenues over the term of the agreement.  As another example, international presale contracts can be "recognized" as executed, although the cash-flow from those forms of sale is not generated until the movie is actually delivered to the purchasing entity.  An airplane manufacturer such as Boeing / Spirit Aviation might immediately "recognize" ("book") the revenues from a $50-billion contract for jet planes, even though it might be years in the future before the actual delivery of planes occurs and the payment is rendered;  meanwhile, they can expense the tools, staff and manufacturing costs related to that sale, as it has already been recognized as an offset to the revenue portion of the transaction.

It has been no secret that Hannover House incurred a lot of debt in 2010 with the acquisition and release of the film "Twelve."  It has also been disclosed that the company is choosing to immediately reinvest as much "surplus" cash flow as possible in release activities (growing our revenues, stature and bottom line with more DVD, Book, VOD and International releases).  Managing the old debt, maintaining the operational overhead, and investing in an enhanced release slate are all drains on the company's cash flow resources.  Confusion has occurred when some shareholders look at the consistent (and growing) profitability for HHSE and assume that accrued sales to Netflix (for instance) equals immediate cash-in-hand today.  Unfortunately, it doesn't work that way.

If Hannover House selected an amount of cash to "sit on" (such as $250,000 to have "on-hand" at any given time, but simply not ever touched), this would not be a good use of the capital in Management's opinion.  There are income producing opportunities and releases requiring modest investments, and it's arguably bad-form to sit on cash when some creditors have been patiently accepting small payment installments over the past few years.  The HHSE management treats cash with great respect.  We use it to build the business with new releases, while balancing the obligations from the past with the current operational needs. 

On an accrual basis, Hannover House is consistently profitable - and it's likely to grow exponentially this year.  But on a cash basis, if the company is ever significantly CASH RICH, then we're probably missing out on growth opportunities to benefit shareholders... and this philosophy of reinvesting all reasonably available revenues should persist at least until HHSE achieves the level of $100-mm per year in revenue turnover.

If cash-vs.-accrual accounting is too complicated for some people to understand, perhaps they are better suited to invest in a neighborhood coffee shop... something that doesn't require much brain power to follow and accurately analyze. 

Hannover House is competing in the same arena as media giants, and the company is surviving and growing without the huge resources that a Comcast or Sony can access.  The upside for our shareholders is phenomenal, and the ability to reach such goals is realistic and proven through the prior successes of CEO Eric Parkinson (as C.E.O. of Hemdale, e.g. "Terminator", "Platoon", "Hoosiers") and D. Frederick Shefte, Esq. (as a partner in the prestigious San Diego firm Seltzer, Caplan, Wilkins & McMahon). Thanks to our many, legitimate shareholders and supporters, this is going to be a very exciting summer and year for HHSE.