Imagine you deliver a service or product today, but don’t send the invoice until next month. Is this transaction reflected in your accounts? In accrual accounting, you also include those accrued costs and revenues. This means you have a clear insight of your financial situation at any time and you can make informed business decisions. Find out what accrued costs are and why it is worth including them in your balance sheet.
Why having an insight into your company’s financial situation is so important
As an entrepreneur, you probably work very hard every day. However, that doesn’t mean your business is successful. For your business to grow, you need an insight into your financial figures. Is all your hard work earning you enough money? Are you anticipating a downturn or a big investment that you should prepare for? And does your profit-and-loss account take into account the real financial picture at this moment? Often, this last question is where things go wrong.
Cash-based accounting versus accrual accounting
Many start-ups and smaller companies have cash-based accounting, and do not book their costs or revenues until the money actually leaves the account or is in the account. This gives you a distorted idea of your profits. Imagine you provide services or sell a product in February, but you’re not paid until March. This transaction will only show up on your balance sheet in March.
Accrual accounting takes sales into account when the sale actually takes place. This type of accounting follows the matching principle: you account for related costs and revenues in the same period.
Accrued costs and revenues
Accrual accounting therefore takes short-term accruals into account. And they exist in 2 directions:
- Accrued costs: you have already used services or products which you have not yet paid. Think of monthly cleaning costs that are paid per trimester, advertising costs or an order with a deferred payment. Or you give your customers a volume discount.
- Accrued revenues : you have already provided services or goods for which you did not yet send the customer an invoice.
Accruals are not reserves
What is the difference with reserves in your accounts? A reserve is built up to cover possible losses or investments in the long term. And you know exactly when accrued costs and revenues will be paid, which is often not the case with reserves.
Advantages of accrual accounting
Regardless of whether you choose cash-based accounting or accrual accounting, your final turnover remains the same. However, accrual accounting that takes into account accruals does have other advantages:
- You know at any time exactly what you still have to pay and receive.
- You have a far more accurate and detailed idea of your turnover – regardless of the terms of payment.
- You can plan ahead more easily. This allows you to maintain your stock levels and hire the necessary staff in good time.
Questions about accruals? Ask CFOrent for advice
Accrual accounting works best if you respond quickly in terms of your balance sheet and profit-and-loss account. No time? Let CFOrent help you. As freelance financial professionals, we closely follow your business figures, correctly estimate costs and revenues of provided transactions and help you to interpret your balance sheet. This allows you to make better decisions, in the short and long term.
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