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The importance of accrual accounting

When it comes to accounting, there are usually many different ways to do one thing. This also means that there are also a few different ways that you can record your accounting. The one we’ll discuss in this article is accrual accounting.

 The importance of accrual accounting title image

What is accrual accounting?

In accounting, the accrual method is recording financial events right when they happen, rather than when the payment is made or received. This method works for both income and expenses.

In other words, the income or expense is created as soon as the job or expense is ordered, even if you have not received or sent the money.

Accrual accounting examples

As an income example, let’s say a construction company is hired on November 12th for a job that will take place on December 20th. The construction company will record the income (invoice) on the date that they were hired, even though they will not receive payment until the job is completed, which may be in the next accounting period.

As an expense example, we’ll say that a restaurant orders fresh produce from a supplier. The restaurant orders on a Monday, and the produce will be delivered the following Monday. The deal with the supplier is that the invoice (issued on the first Monday) must be paid within 30 days. The restaurant will mark it as an expense the day that it is ordered, rather than the date the payment is taken.

Accrual accounting vs. cash accounting

So now you understand how accrual accounting works. Cash accounting is the exact opposite. Instead of recording the income or expense when it is created, cash accounting is when you record it on the date the payment is made or received.

For example, let’s say that today a delivery company receives an order to be delivered in a weeks time and will be paid upon delivery. Instead of having the reports reflect the income on today’s date, the reports will show the date that the payment was received.

Why is accrual accounting important?

While cash accounting may be easier to understand, accrual accounting is definitely a useful tool for many reasons.

Assessing performance

Compared to cash accounting, accrual accounting portrays a more accurate statement of the company’s health as it includes both accounts receivable and accounts payable.

It shows an instant portrayal of the money coming in and what they can expect on future reports.

Accuracy

Accrual accounting provides a more accurate depiction of a company’s financial activity. Since the income and debt are precisely outlined, this allows the business to manage the patterns of their financial activities.

Future planning

Accrual accounting is done in real-time making it easier for management to view a detailed overview of the business finances at any given time. This will allow them to assess previous progress, and create new plans for the future with an accurate budget.

Receive funding

Accrual accounting is the more commonly used method, and potential investors and shareholders may want to see reports using this method. Reports showing a good flow of income over a specific period will entice potential investors.

Using invoicing software for accrual accounting

Invoicing software are powerful and intuitive programs that allow you to issue invoices, accept payment, record expenses and keep track of your accounting reports. Most invoicing software, including Debitoor, allow you to choose how you would like to record your accounting.

In just a few clicks, you can change your reports from cash accounting to accrual accounting. To do this with Debitoor, simply go to ‘Settings’ > ‘Business Information’ and toggle the button ‘Base reports on payment dates’ ON or OFF.

 How to change to accrual accounting with Debitoor

Then, when you open the balance-sheet or profit & loss statement, the changes will be reflected.