Accrual Accounts Explained

I bet you never knew that you had to virtually be an accounting major to start a business.  No matter what type of business you choose to start, you have to pick a method of accounting your money.  Your choices are either the accrual method or the cash method.

Here we will explain the accrual method of business accounting.  In any business there will be money coming in and money going out.  Ideally we want more money to come in than is going out.  But regardless what happens, our books have to show where the money is located.

If your business plans to use the accrual method, there are a few things you should know.  Firstly, with this method, money is counted as either coming or going when the deal is made.  For example, say you own a shoe company.  A store wants to order 100 pairs of your shoes.  If the order is placed in June, the amount of that order is recorded in your books for June.  The shoes haven’t been shipped out yet, but the order has been placed.

The same goes when your money is spent.  Let’s use the same example.  The 100 pairs of shoes are ready.  You ship them out to the store in July.  On the books, the price of the shoes, $9,000, is recorded as paid in July.  The payment hasn’t been received yet but according to the accrual method, the money is recorded in the company ledger when the items are shipped out to their destination.

The accrual method of accounting allows a business to count and deduct money before transactions are finalized.  It is not always easy to tell which date the sale happened on.  Businesses are used to dealing with dates on checks and shipping invoices. 

The date that the agreement was made may or may not get written down.  Whichever way you choose to determine the date, make it a uniform system.  One thing to remember is that the items have to be shipped and if you are receiving a service, it has to be completed before writing it down.

The accrual method lets you see at a glance how much business is done in any given month.  This will help when budgeting for the coming year, hiring employees, and deciding on discretionary funds.  On the downside, recording profits can leave you with a slanted picture.  The books may show that you made $100,000 in June because that is when your inventory shipped out.  However, the money could actually have come in much later, say on the 30th of August. 

There are good and bad points about the accrual method.  However, as long as you keep a sober head about the way to view your books when using accrual accounting, your business won’t suffer any ill effects.