When you first start a business, you will most likely track your earnings based on cash exchanged. It is the easiest way to note transactions, especially for small companies. However, it will eventually be more efficient to measure revenue, make projections, and compile taxes for entrepreneurs with accrual-based accounting.
This type of accounting takes note of transactions and obligations instead of payments. It means that you tally income or expenses upon signing an agreement, providing a service, or ordering an item. Accrual-based accounting differentiates a transaction and a payment; the former is a two-way exchange, while the latter moves money in one direction.
Here are a couple more reasons why you should shift to this type of record-keeping and how you should start implementing it.
It allows you to make better financial decisions
Moving to a bigger office, upgrading your technology, and hiring specialists for your company all sound like priorities. Unless you have the budget for all of them, though, you would need to choose among these. There is no objectively better choice, but if you know your cash flow and how much money you can spend, you can answer that yourself.
Cash flow is easy to establish if your business relies on single transactions. With a subscription business model, though, you will find it more challenging to discern how much money you have on hand. Books that rely on accrual reporting allow your accountants to plan strategically since your assets and liabilities are already tallied.
You can track and monitor business trends accurately
With this type of accounting, you can see which expenses are tied to which revenue. Accrual-based reporting helps you identify business trends and pinpoint the investments or efforts that increase your company’s productivity.
Furthermore, this type of accounting lets you tie revenue with internal processes such as marketing tactics. Doing this will make you a better strategist and lead to more successful campaigns in the future.
Implementing accrual-based accounting
Making the shift from payment-based to accrual-based reporting should be relatively quick and straightforward. You only need to consider two things—revenue and expenses.
Revenue
When you make a sale or accept a contract, mark it as “accounts receivable,” which means you are anticipating but have not yet received the revenue. You will then list this under “current assets” on a balance sheet.
As you fulfill your service obligations, you must update the revenue earned. Revenue recognition is an integral part of accrual reporting, so consult your accountants for guidance.
Expenses
The counterpart to revenue is expenses. You mark them when you receive the services or products, not when you pay for these. Expenses are also classified under “accounts payable,” making it an ensured pipeline out. You expect to spend money, so this type of item should be part of the “current liabilities” section of your balance sheet.
Conclusion
Accrual reporting lets you account for payments you expect to receive in complex contracts or a subscription-based business model. If you want to scale your business, you must shift to this kind of accounting as soon as possible. If you’re wondering about the specifics of doing this, you can ask an expert for assistance.
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