Financial records have different methods of being kept, and two of the most common approaches are accrual and cash basis accounting. According to a study of small business owners done by Clutch.co, more than half (67%) “of small businesses… use the accrual basis method.” Why are more companies using accrual accounting, and what advantages could it offer over cash basis?
The case for accrual accounting is due to several factors, including but not limited to accuracy of financial statements, real-time reporting of finances, and future-proofing for investment opportunities. Financial statements for business at scale must be accurate to ensure correct budgeting and forecasting. As accrual basis is used, the reporting of finances can be done at real time to see when transactions such as income or expenses occur to give a better understanding of the company’s operations.
With on-time and accurate reports available, the organization can be prepared for future opportunities when investors may offer funding contingent on the performance of the company and the level of detail in the books. These key components and more give greater reason for any company to utilize accrual accounting. In contrast, while cash-basis can show cash flow and be more easily understood, it does not utilize double-entry accounting which shows debits and credits across various accounts of a company.
Yet another downside is the limited scope offered by cash-basis, which can, at times, be misleading. For example, one month could appear to be highly profitable when in reality multiple clients came in to pay outstanding balances while sales stagnated. For a quick look, it can be easy to think cash-basis is good for reporting of financial statements, but it is more important to remember that accurate accounting needs to include a broader scope as in accrual.
Whatever the situation for a business may be, financial statements are a necessary component to success. As accounting is the language of business, leaders of any organization should have an understanding of what kind of accounting is right for their organization such that important decisions can be made with tact and care. For business professionals looking for professional advice, reach out to JTC CPAs and learn more about accrual accounting and how it can help your business grow.