Cash accounting is a simple way of keeping track of a company’s funds. Many small businesses start with cash based accounting in their infancy and move to accrual based accounting as their business grows in size and complexity. Cash basis accounting is appropriate in situations where the expense of complying with the accrual-basis method of accounting outweighs the need to produce accurate financial reports. This usually applies to sole traders, small businesses that don’t extend credit, as well as certain non-profits and governmental departments. On the other hand, there may be businesses where cash basis accounting is simply not feasible. Businesses such as manufacturing, construction, food service, or retail – where margins may be small and detailed accounting may be necessary in order to make informed business decisions – may simply require accrual accounting from the start and why not. The benefits of accrual accounting are many.
5 Key Benefits Of Accrual Accounting
Benefits Of Accrual Accounting #1: A Better Picture Of Financial Performance
In most medium-large businesses where funds are transferred back and forth on paper more often than cash itself, relying on cash accounting would be a crude, inaccurate way of gauging the financial status and performance of the business. Accrual accounting easily allows the business owner to see at a glance if the company is profitable, where the profit is coming from, and where expenses are going. Accrual accounting also matches revenues with the expenses the company incurred to produce it.
With cash accounting, any account payables or receivables wouldn’t be accounted for until the money actually went in or out of the company. For example, with cash-basis accounting, a company could be showing a positive cash picture even if the business is verging on bankruptcy, since there may be expenses that have accrued, but which the company has not yet paid. In any business where transfer of funds might not match the transfer of goods or services (virtually any business aside from certain small sole proprietors), cash-basis accounting simply cannot provide an accurate financial picture of a company.
Benefits Of Accrual Accounting #2: Tracking Historical Trends
Cash basis accounting is able to track the flow of cash in and out of a business, but it doesn’t accurately reflect the flow of revenue and expenses in and out of a business. Because accrual basis accounting tracks revenue and expenses as they are incurred, it creates a more accurate record of the business’s activities. Managers can use this info in order to identify sales trends related to economic conditions or occurrences in the marketplace.
Benefits Of Accrual Accounting #3: Access To Credit
While small cash based businesses may be able to get away with cash based accounting for awhile, as a business grows, there will be a point where it is no longer sufficient. In order to expand, or even to survive, most businesses will depend on credit. Accrual accounting allows companies to record and measure credit – both credit owing as well as owed.
Benefits Of Accrual Accounting #4: Meeting GAAP
In the United States, GAAP (generally accepted accounting principles) is considered the industry standard for preparing financial statements. In fact, companies in the United States with $5 million dollars in annual sales or $1 million dollars in annual inventory sales are legally required to use the accrual accounting method as part of GAAP in order to report their financial information and for income tax preparation. Meeting GAAP allows a company’s financial picture to be easily accessed by investors and other financial institutions.
Benefits Of Accrual Accounting #1: Allows Financial Managers To Better Use Company Resources
The accrual method is not only necessary for larger corporations, but the more accurate financial picture it presents allows business owners and financial managers to better use a company’s resources. The ability to expand the business can be limited if the company is only able to account for cash that has been paid, and the company may put itself in a precarious position if it spends cash that should be earmarked for creditors. Additionally, the standard use of accrual accounting allows managers to analyze the full cost of a product or service to industry standards.
Switching To The Accrual Method
While the Accrual method is important in the growth of a company, small businesses that don’t extend credit to customers may prefer cash-basis accounting, as its less complicated and time consuming than Accrual accounting. However, small business owners and managers anticipating future growth would be wise to take the time to learn and understand accrual-basis accounting and the benefits of accrual accounting
By Richard Orban, on behalf of. Wallace is the best source for .
- 1 5 Key Benefits Of Accrual Accounting
- 1.1 Benefits Of Accrual Accounting #1: A Better Picture Of Financial Performance
- 1.2 Benefits Of Accrual Accounting #2: Tracking Historical Trends
- 1.3 Benefits Of Accrual Accounting #3: Access To Credit
- 1.4 Benefits Of Accrual Accounting #4: Meeting GAAP
- 1.5 Benefits Of Accrual Accounting #1: Allows Financial Managers To Better Use Company Resources
- 1.6 Switching To The Accrual Method