As businesses became more complex, the need for accurate financial information increased. Transactions like buying and selling on credit, and projects with long-term revenue streams impacted a company’s financial condition. Therefore, these events must be reflected in the company’s financial statements during the same reporting period. Accrual accounting provides immediate feedback on cash flows, making it easier for companies to plan for future events. Here are some key benefits of accrual accounting.
Inaccurate accounts indicate profits when there are no cash inflows. For instance, a supposedly profitable business may be starving for cash. Moreover, it may go bankrupt despite its claimed profitability. The statement of cash flows shows whether money is coming into or leaving the business. As a result, an accrual basis of accounting is not suitable for every business. Rather, it is better to use accrual accounting for companies that have higher revenue and higher sales.
Accrual accounting can be tricky to implement. It requires an accountant with advanced knowledge of accounting principles. Moreover, the transition from the traditional method to the accrual one can be challenging. Some businesses have cash flow problems that aggravate the process. However, some businesses benefit from using the accrual method as a means of improving their cash flow. Further, it can improve transparency and increase financial insight. So, whether you want to use accrual accounting or not, make sure to consult a professional accountant for guidance.
Unlike cash accounting, accrual accounting records revenues and expenses as soon as they are incurred. It also matches expenses and revenues to the same time period, enabling better assessments of profitability. Companies that use accrual accounting almost always have inventory or sales on credit. For example, a consulting firm may provide a $5,000 service to a client on Oct. 30. The client will receive a bill for services rendered on Nov. 25. If it had used the cash method, it would have recorded the entry differently under accrual accounting.
Another common example of an accrued expense is an internet connection. Suppose a company needs a high-speed internet connection to conduct business in January. The bill will not arrive until March, but the company will incur the expense during the entire month of January. Thus, the internet bill would be recorded as an accrued expense at the end of January. In the same way, it would be easier to forecast future revenues and liabilities by using accrual accounting.
With the accrual method, transactions are recorded when the raw materials are ordered, or services are rendered. However, there may be instances when a customer still owes the seller money. The supplier would record the expense on the day the payment is made. Consequently, this type of accounting method provides a better picture of the financial condition of a company. In addition, accrual accounting helps companies avoid the potential tax liability resulting from not receiving revenue.