While accrual accounting is the more complex of the two accounting methods, it is considered the standard accounting practice for most businesses, except small businesses operating on an all-cash basis, and provides some distinct advantages:
- By using accrual accounting, companies can look at both current and expected cash flows, providing a much more accurate picture of the organization’s financial health.
- Accrual accounting shows underlying business transactions, not just those involving cash. Many transactions may be relatively straightforward, with payment received or made at the time of the transaction. Other transactions, which may be more complex, involve buying and selling on credit. This requires the company to account for monies that will be paid or received in the future.
- Accrual-based accounting is likely to be more accurate regarding a company’s assets or liabilities. Adhering strictly to a cash-basis system, a company’s accounting may leave out crucial information regarding unpaid invoices or liabilities, which could cause the omission, however unintentionally, of certain assets.
- The timing of when revenues and expenses are recognized can have a major effect on a company’s perceived financial health. One example of this can be found in the construction business, where a company may take on a long-term project and not receive cash payments until the project is completed.
- Using the accrual method, a company would benefit from something called the percentage of completion method, in which the construction company mentioned above, for example, would recognize a percentage of revenue and expenses proportionately as the project was completed. In this case, the accrual method would show the prospective lender a more complete picture of the company’s revenue channel.
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