Advantages of accrual accounting
Recording cash transactions based on when you complete services, deliver products, and incur expenses is also beneficial to your business.
Here are the main advantages typically associated with accrual accounting.
- Provides a more accurate view of your business’s performance: Since you can measure profitability and business activity during a specific month or year.
- Makes it easier to track revenue if you sell on credit: Since you record the transactions when they happen instead of after payment.
- Can defer your tax liability: Since you can delay paying taxes on a certain income if a customer pays the year after it was delivered.
Still, it’s important to review the IRS guidelines on how to report an advance payment for services using the accrual accounting method.
Disadvantages of accrual accounting
Whereas accrual accounting’s strengths lie in accurately showing business profitability and representing long-term revenues and expenses, it has a few drawbacks as well.
Here are some pitfalls of accrual accounting:
- Does a poor job of tracking cash flows: Since your bank account may show a smaller balance than your income statement if customers haven’t paid what they owe you.
- Requires more bookkeeping and staff resources: Since you need to track cash flow separately to cover your bills which can be more complicated and expensive to implement.
Due to the added complexity and paperwork required under the accrual method of accounting, small business owners—particularly when starting a business—tend to view it as a less ideal option than the cash accounting method.
Streamline your accounting and save time
Accrual accounting provides a better picture of your overall financial position, and many companies consider it to be the standard and more accurate accounting method. But it can also be too complicated and expensive for small business owners.
One way to offset the people and time resources required under accrual accounting is to invest in accounting software that does the hard work for you.
Accrual accounting FAQ
Still have questions about accrual accounting? We’ve got the answers.
What is an accrual in simple terms?
Accrual accounting is when you recognize a transaction in your journal entry when it happens instead of when you receive payment.
What is the basic rule for accrual accounting?
The basic rule of accrual accounting is to record transactions when they happen instead of when you receive or deliver payment.
What are the three accounting methods?
The three accounting methods are cash basis accounting, accrual accounting and modified cash basis accounting, which combines cash and accrual accounting.