Cash Basis vs Accrual Basis – Forbes Advisor

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Accrual accounting tracks revenues as they are earned and expenses as they are incurred. This system uses Accounts Payable and Accounts Receivable to formulate an accurate, real-time picture of your company’s financial condition.

  • Accounts payable: Money your business owes to suppliers or creditors.
  • Accounts Receivable: Amounts owed to your company for services rendered.

Businesses that use the accrual method to keep an accurate picture of accounts payable and receivable will keep their records based on the current status of an invoice or invoice. If, for example, you have a long-term relationship with a particular client, there would be documentation showing when the service was rendered, the date an invoice was generated, and when the invoice was paid. The same goes for ongoing relationships with the vendors you do business with.

These documents reveal when you receive payments and any invoices that are still outstanding. Likewise, you can list invoices your business has already paid and any expenses or debts that have not yet been paid. This method makes it easy to update the unique status of each sale or invoice, making adjustments when each item is satisfied or taking notes on anything that remains outstanding.

Therefore, the accrual method ultimately provides a better overall view of your business’ financial condition, considering much more than cash flow or cash.

When to use accrual accounting

Accrual accounting is often a must for large businesses, as they tend to have far too many moving financial parts to rely on the much more simplistic approach of cash accounting. A few cases where the accrual method works best:

  • When you accept or make credit card payments: While cash payments can be posted fairly quickly, it takes time for credit-based statements to arrive. Additionally, these payouts can be posted days or weeks after the initial transaction.
  • Active and passive tracking: In addition to cash, businesses also count checks, short-term investments, and inventory as assets. Similarly, any unpaid expense is a liability, recognized before invoices are paid rather than after payments are sent. Accrual accounting makes it easier to distinguish between assets and liabilities by keeping up-to-date records of what falls into either category and for how long.
  • Ensure compliance with GAAP: Public companies in the United States must adhere to generally accepted accounting principles, or GAAP, as decided by the Financial Accounting Standards Board (FASB). Therefore, these companies are required to use accrual accounting, as it follows GAAP standards.

Additionally, accrual accounting provides a complete and accurate picture that cannot be manipulated. When valuing a company based on exactly when money is available or paid, it is easier to misinterpret a company’s financial condition. The accrual accounting approach requires accounting for everything in a timely manner.

Disadvantages of the accrual method

Although a highly reliable and preferred form of accounting, an accrual accounting setup has drawbacks:

  • It’s very complex. Accrual accounting requires much more detailed record keeping. Even with the right software, business owners unfamiliar with this type of accounting may initially find it very difficult to use.
  • This can consume a lot of time and money. Maintaining a series of documents year after year and constantly checking for changes and updates is very time consuming. As the business grows, it will likely need to outsource business record keeping or software tool upgrades.

Ultimately, this method may become more expensive or time-consuming, making it more difficult for small businesses to use.

Best Accrual Accounting Software and Services

The larger and more complex your business becomes, the more willing you should be to switch to accrual accounting software and services. For example, Intuit’s QuickBooks Online lets you switch from cash to accrual accounting. This subscription-based service helps you track invoices, expenses, employee hours and more. If you work with an accountant, you can easily share your spreadsheets to provide accurate insight into your finances and tax obligations.

Please read our review for more information on QuickBooks Online and our ratings for other best accounting software.

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