Understanding The Pros And Cons of Accrual Accounting
Businesses have to record their income and expenses for various reasons. There are two ways to do this– accrual and cash-based accounting. Most medium and large businesses employ accrual accounting as it is more transparent and in compliance with regulations. If you run a business, it is essential to understand what accrual accounting is.
Some small businesses use cash-based accounting, where revenue is only recorded when it changes hands. Regardless of the size of your organization, accrual accounting is more acceptable and required by the Generally Accepted Accounting Principles (GAAP). Any good accountant in Little Elm should recommend the same method.
Pros and cons of accrual accounting
PRO: Accuracy.
Accrual accounting offers a detailed illustration of the financial health of your business than cash-based accounting. This is because it does not only show the money you already have but your future earnings and income as well. For example, a company spending too much is not healthy when it has not even gotten paid yet from its clients. It also allows investors and lenders to get better insights.
CON: Switching to accrual accounting can be hard.
Even though accrual accounting is the preferred method, switching from a cash basis to accrual has some challenges. Both the development as well as the implementation of the system can be hard. In some cases, implementation is done step-by-step over a period of several years instead of doing it overnight. Such problems are more likely to occur if your business has cash flow issues.
PRO: It is compliant with GAAP.
Even if you have not yet adopted the accrual method of accounting, the fact that the GAAP now requires it is a solid reason for the change. If you have a small business right now, it might eventually grow in the future. Therefore, it is better to have this method already instead of having to change it later on.
CON: Complexity.
Cash accounting is more straightforward than accrual accounting. Cash accounting records income and expenses as they happen. Therefore, there is no ambiguity about how much money there is in the business. When using the accrual method, companies have to follow GAAP guidelines strictly. Some of them are not intuitive, making things complex.
PRO: Accrual accounting streamlines strategic planning.
Accrual accounting tells you how much money or income will be coming in the future. Therefore, it makes the perfect method for strategic planning. Planners can see if there is high or low cash flow. This enables you to have a more accurate forecasting of your company, which makes maximizing opportunities more efficient. You will also be able to handle periods of financial crisis better.
