Let's start with basic definitions. Accrual accounting income and expenses are recorded at the event, not a transfer payment. Revenue is recognized when it is received, not when payment is received. Expenses are recognized when incurred, even if you have a 12 month payment plan.
So, how might this affect your business? Let's look at some examples.
Profit Before Recording Payments ReceivedA good example would be sales generated with Net 30 payment terms. In accrual accounting as soon as the physical product have been submitted you will book revenue. Your income will include income even if you do not receive the money. Sounds great right? Not so fast. Let us consider the other side.
Waiting For the Record Revenue Even When Payment ReceivedIt makes no sense right? If they pay you, well hey they pay you! But if you get it? You may be thinking well sure, not like I was stealing money.
In accounting earn revenue means that you have done all the services that were promised for money received. Let us take a prepaid gym membership. You run the gym, and costs $ 1,200 per person, payable in advance, for 12 months membership. In accrual accounting you will not book the entire $ 1,200 as income immediately. You have not provided the service or not. Instead you order $ 100 per month every time you provide this service.
The goal of accrual accounting is to reflect the business activities at a particular time point.
- Benefits of Accrual Accounting for More accurately match revenues and expenses at a particular point in time, give a better picture about the health of your business
- Great reminder you still need to provide service to hang onto your cash
- Making a reality check for the cost of purchased on credit
- Lack of Accrual Accounting you may end up paying tax on income before you actually receive cash
- Significantly more difficult to reduce taxes by accelerating or delaying spending
- It's easier to forget the fact that some of your income is not money in the bank
- Tracking and reporting more complex than cash accounting
It is important to note that the accrual accounting may become necessary depending on the type of business you run, and legal structure. Additionally, if your business has revenues of more than $ 5 million, you may be required to use accrual accounting. To determine whether there situations applies to you, be sure to consult a professional. If there is no requirement, it will be important to consider the benefits, and constraints in relation to your business, before deciding whether accrual accounting is right for you.
Small Business Financial expert Nicole Fende offers down to earth tools, tips and advice for entrepreneurs, independent consultants, artisans and small businesses that established that wants to expand their business, reduce costs, and increasing business profit