Has your accountant ever used the term “accrual based accounting” or tried to explain it to you?
Riveting stuff, huh?
What do you really need to know about accrual basis accounting?
- Accrual basis accounting records and reports your revenue, costs, expenses and purchases based on when the transaction actually takes place in time, not when the cash ultimately exchanges hands.
- Unless you’re a solopreneur with no employees, the only true way to track the financial results and financial health of your business is with accrual based accounting.
- If you don’t know your numbers, you don’t know your business. And the only meaningful numbers are tracked and reported on the accrual basis.
Cash basis accounting reports on the cash exchanging hands.
The only exception is that it will often include credit card transactions.
It gives no credence to the fact that your biggest invoice last month was not collected, until this month. There is no reflection of the revenue attached to that invoice until the cash actually lands. Inside of this system there can be some wild distortions on a month-to-month basis of profitability, profit margins, and the appearance of the company’s ability to cash flow operations.
The only way to effectively analyze the financial results of the operations is tracking everything on the accrual basis.
Accrual simply means an accounting system that is reporting your business transactions as they occur in time, whether cash has exchanged hands or not.
When the accrual system is managed correctly, the business recognizes revenue as it is earned, and expenses as they are incurred, whether or not the cash has exchanged hands.
The accrual system is the only way to report how well your business is performing operationally, whether that be monthly, quarterly or annually.
It is also the only effective way to report the financial health and stability of your business, based on KPIs such as: accounts receivable aging, payables aging, liquidity ratios, among others.
Do you know if your accounting firm tracks on an accrual or cash basis?
Many of the low-priced accounting firms out there exist because their system is merely attaching bank accounts and credit card accounts to accounting software. The results are cash basis financial reporting- which, as we’ve covered, is a waste of time and resources.
At Financial Optics we know you’re trying to stay on top of everything in your business. It’s a lot to master for any entrepreneur. If your current accounting solution does not track on an accrual basis it’s time to make a change. If they do, ask them to start explain the financial reporting to you and to help you use that information to grow a business with bigger profits and improved cash flow.