While cash accounting is the simple way to keep track of income and expenses, accrual accounting is a gauge of the status and performance of a company. It has the advantage of being very transparent while recognizing the financial hills and valleys that affect a going business.
Beyond transparency, the biggest advantage to accrual accounting is the ease of interpretation it allows the company owner who needs to know if the company is achieving profit level.
It does not matter the size of a company, all companies can use the accrual method to their benefit when tracking expenses and acquisitions. However, large companies buy or sell on credit and take on the bigger projects that need a continuous long-term infusion of funds. This necessitates the production of financial statements on a regular schedule.
This accounting method tends to overstate revenue as opposed to the cash method of accounting. The accrual method records income as the company earns it and not when they receive it. Likewise, a record of debt merits an entry when the purchase occurs and not when it is paid. Accrual accounting treats accounts receivable as an asset and allows the report to print with other periodic financial statements.
Transparency in Reporting
The General Accepted Accounting Principal requires c-corporations and government entities to use accrual accounting. This method places a greater focus on the output of a business rather than input. It also improves accountability and provides for better financial management.
Many government agencies are new to this accounting method. These public agencies use private entity financial statements. Therefore, they should use the same accounting guidelines to achieve an accurate level of comparison with the companies and corporations. The shift to accrual accounting will add a layer of transparency and government accountability not visible in the past.
Just One Tool
Management uses several tools to assess various company aspects. Accrual accounting is just one of those tools. The accrual method improves data input integrity as well as the resulting report generation. Decision-makers can use the financial statements to analyze profitability and determine the best direction the company should take.
This one tool clarifies the income statement and the balance sheet. Income statement is an indicator of financial performance and a balance sheet shows financial health. Accrual accounting also makes tracking accounts receivable and accounts payable more efficient.
The accrual method provides a snapshot of the financial reality of a company. This method enhances the possibility of predicting future cash flow correctly. Finally, this accounting method helps to compare performance and stability from one reporting period to the next.