Accruals are amounts of money a business expects to receive or spend, which haven’t been paid yet. This method is sometimes referred to as ‘traditional’ accounting.
Maintaining good bookkeeping records is critical for your own decision making, HMRC, and any financial backers, so in this article we explain how different types of accounting system affect your bookkeeping.
How do accruals work?
Accruals are a way of accounting for business expenses and income even if the actual payments haven’t happened yet. For example, when you create an invoice to send to a client you’ll record the invoice as a transaction in your bookkeeping, even if they don’t pay for a while.
Accounting for a transaction using the accruals method
At the end of May you invoice a client for some work you carried out for them at the start of the month. They don’t pay the invoice until July, but you still record the income in May.
That way your business accounts show when the sale took place, as well as when the payment was received. This kind of data can be incredibly useful because it can help you identify periods that are busier than others, or spot clients who tend to take longer to pay their bills than others!
It works the other way too. If you receive an invoice from a supplier you’ll account for the transaction when it happened, even if you don’t need to pay the bill straight away.
The main benefit of using accrual accounting is that it helps you keep a clear picture of your finances and revenue over a particular period. This can be a great way to predict future revenue and expenses, which is key to making solid business decisions.
It’s also beneficial if you need to get finance for your business, giving lenders or investors a better idea of where the peaks and troughs occur in your business, and therefore your finances.
Are accruals different to cash basis accounting?
Yes, the accrual method is different to cash basis accounting. Rather than accounting for the transaction when it happens, the cash basis method accounts for it when the payment is made.
Accounting for a transaction using the cash basis method
At the end of May you invoice a client for some work you carried out for them at the start of the month. They don’t pay the invoice until July, so you record the income in July.
Even though you won’t account for the transaction until July, it’s essential that you still have a record of the invoice. That way you can keep track of any late payments!
Can anyone use the accrual method for accounting?
Yes, the accrual method is an option for most businesses – although it’s worth noting that it’s a requirement for limited companies, or any business structure with an annual turnover above £150,000. It can be particularly useful for more complicated organisations, or those with a high level of stock.
What accounting records do I need to keep?
The accounting method you use dictates what information you need to record. Under the accruals system you’ll need to keep a record of everything you are owed but haven’t yet received, and what you’ve committed to pay but haven’t yet paid. You’ll also need to keep details on the value of any stock, as well as any work in progress at the end of your accounting period.
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