Business entities make periodic business decisions to ensure smooth operations. From products and services to operations and business strategies, the decisions carry utmost importance. While talking about the strategies, large companies will give a thought to the accounting system in place. Be it cash-based or accrual-based accounting, the management needs to think about its advantages and disadvantages. For start-ups and small businesses, cash-based accounting is best. But when we talk about large companies, the choice becomes difficult since both systems come with pros and cons.
The debate is time-consuming, but we will discuss some of the prominent advantages and disadvantages of accrual-based accounting to cut it short. Let’s get to work!
Positives of accrual-based Accounting system:
Recording transactions will not have as much significance for your business as recognizing them. The former is about a cash-based system, while the latter reflects the accrual-basis system. Before delaying it further, let us jump into the advantages of accrual-based accounting.
1. Business Analytics:
Business analysis changes considerably when we switch the accounting system. Talking of the accrual system, it portrays a more accurate business picture. When a business purchases a piece of expensive machinery, it will be recorded in the current accounting period, irrespective of the payment. Doing so will spread the amount over to the next accounting period(s).
Large companies are often involved in purchasing heavy machinery on credit terms or delayed payment. The accrual basis benefits them mostly since the expense will spread over the next periods. Doing so will represent an actual summary of your business transaction, helping the management make more informed long-term decisions.
2. Compliant with Generally Accepted Accounting Principles:
Generally Accepted Accounting Principles (GAAP) set by the Financial Accounting Standards Board (FASB) prefers accrual basis. What makes them favor this system is that it simulates the economic reality of a business. Moreover, the financial statements, prepared periodically, will intimate a more accurate financial position.
Most businesses often try to do away with these compliance matters, which is unwise. It’s either they don’t understand it or don’t have efficiency for it. The best way to excel at it is to hire expert bookkeeping and accounting firms in Dubai. Compliance is easier when you have a professional on board.
3. Preferred by Investors:
Any business that uses an accrual accounting system will send a strong signal to the stakeholders. Be it a financial institute, a creditor, or investor, they will perceive the business as well-established and organized. The point that only large businesses can benefit from this system comes in very handy here. Rest assured, investors will more likely put their funds into an accrual-based company.
4. Informed Business Planning:
Accounting of your revenues and expenses in a particular period can help you better plan your next move. Unlike a cash-based system, you will record recognized expenses and incomes, irrespective of the cash inflow or outflow. A vivid picture of business operations and financial statements will help the management make long-term decisions.
Budget planning is the most important one of all. Finance your projects and make future projections with an accrual-based accounting system.
Negatives of Accrual Accounting System:
With the benefits, there is an equal chance that it can bring adverse effects for your company. It would be best if you watched out for these since they can be fatal in the long run.
1. It Poses complications:
There are specific difficulties you might come across when switching to an accrual-based system. One of them is:
- Staffing Issue: You will need to have a dedicated staff to track your expenses and revenues. The accounting department will have to bear the extra charges of keeping a team.
2. Frequent Reporting:
Accrual-based accounting needs a business to generate frequent financial reports. The reason is to keep the transactional history of a company accurate. An in-house accounting team often fails at delivering it.
- Takeaway: Companies should consider hiring professional bookkeeping and accounting firms . With these experts on board, you can circumvent this complication.
3. Tax payment:
You will record income on your income statement that you haven’t received yet. A common legal practice is that you will pay tax on that recognized revenue. Mostly, businesses pay such taxes where the cash is still not received. As a business owner, you will need to keep this point in mind before switching to an accrual-based accounting system.
You went through the positives and negatives of the accrual accounting system. There are benefits, no doubt, but some points will make you reluctant to choose it. The management should make an informed decision keeping in front the business model and structure.
Take accounting experts on board to ensure smooth business operations!
The management, before making any crucial decision, heavily relies on the financial numbers of a company. The accounting department provides these numbers. A little prick can do more significant damage in the long run. To ensure a more sophisticated business environment, take accounting professionals on board!