Imagine you run a small business... You sell handmade bracelets online. You get an order for 10 bracelets in May, but the customer pays you in June. How do you know how well your business did in May? This is where accrual accounting comes in.
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What is Accrual Accounting?
Accrual accounting is a method that records income and expenses when they happen, not just when money is actually received or paid. This means that even if you didn’t get paid right away, you still record the sale when you make it.
Why is it More Accurate?
1. Timing Matters
Let’s go back to our bracelet example. If you only recorded money when you received it, May would look like you didn’t make any sales, even though you were busy making and shipping bracelets. Accrual accounting records the sale in May, the month you earned it. This gives a true picture of your business activities.
2. A Complete Picture
Accrual accounting keeps track of all money owed to you (accounts receivable) and all money you owe (accounts payable). This is like having a to-do list for your money. You can see how much you are supposed to receive from customers and how much you need to pay for supplies. It helps you plan better because you know what’s coming up.
3. True Business Performance
Accrual accounting helps you see if your business is actually making a profit or loss during a specific time. It’s not just about cash in the bank. For example, if you bought supplies in May but paid for them in June, accrual accounting will record this expense in May. This way, you match your expenses with your income for the month, giving a clear picture of how much profit you actually made.
Real (Simple) Life Example
Think of a lemonade stand. You buy lemons, sugar, and cups in May. You sell lemonade all month, but some customers promise to pay you in June. If you use cash accounting, May looks like you spent a lot but didn’t make much. Accrual accounting will show you bought supplies and made sales in May, even if you get paid later. This is more accurate for understanding how your lemonade stand did in May.
Why It’s Important
Knowing the true financial health of your business helps you make better decisions. You can see trends, like if your sales are growing or if you need to cut back on spending. It’s like having a detailed report card for your business.
Accrual accounting might seem a bit more complicated than just tracking cash, but it’s worth it. It gives you a complete and honest view of how your business is doing. By recording income and expenses when they happen, you get a true picture of your business performance, helping you make smarter decisions and plan for the future. So, if you want to know how well your bracelet business or lemonade stand is really doing, accrual accounting is the way to go.
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