Good accounting is essential for the survival and long-term success of every business. Reliable accounting documents should tell an accurate and complete story about an enterprise’s business conditions. Two primary accounting methods make it critical for business leaders to ask, “Which is the right method for my business?” and specifically, “Should my business employ accruals in accounting?” 

The Two Primary Accounting Methods

The two most common accounting methods are cash-basis accounting and accrual-basis accounting. It’s important for each business to choose the method that will best help determine its financial health in both the short and long term. The right method can improve the chances of a business securing debt financing. Based on a company’s size and type, tax laws may dictate which method is used. The right method will make it easier for business leaders to forecast the future growth of the business, based on the size of the business.

What to Know about Cash-Basis Accounting 

Using cash-basis accounting, revenue is recognized when cash is received. Expenses are recognized when payment for costs is made. Income is recorded once revenue is received and expenses are paid. Thus, any long-term project won’t reflect revenues until the project is completed and paid for.  

Cash-basis accounting is typically used for sole proprietors and small businesses because it is easy to use and very straightforward. It is also used for cash-only businesses and businesses operating without inventory.

What to know about Accruals in Accounting 

The accruals method uses two key principles: the revenue recognition principle, and the matching principle. The revenue recognition principle means that revenue is reported when earned or realized. The matching principle means that expenses are recognized in the same period as the revenue that the expenses help generate. Thus, accruals in accounting ensure better insight into a company’s profitability. It also provides a more accurate picture of a company’s assets and liabilities. 

Businesses focused on selling products that require carrying inventory generally use the accrual method because the cash-basis method does not properly account for the cost of goods sold. 

Accruals in accounting are used in larger businesses that are too complex for the simplistic cash-basis method. It is used when a business accepts or makes credit card payments and when it needs to track its assets and liabilities. Public companies must adhere to Generally Accepted Accounting Principles (GAAP) and use the accrual method. Investors and lenders generally require this method of accounting.

The Benefits and Challenges of Using Accrual-basis Accounting 

The benefits of using accruals in accounting include more accurate and comprehensive records with better reporting, improved planning, budgeting, and decision-making, and enhanced liquidity management. 

The primary challenge of using accruals in accounting is that it can be time-consuming and difficult. It requires keeping double-entry books to match expenses with revenues. Thus, it is wise to seek expert accounting assistance.

Seek Professional Accounting Assistance 

Contact Irongate Business Partners, based in Charleston, which serves small South Carolina businesses. We provide bookkeeping, financial analysis, and outsourced accounting services. Some of our major client categories include construction companies, restaurants, HVAC and home services companies, and medical practitioners. We aim to empower growing small businesses with accounting and financial insights and services that otherwise might be out of reach.