First of all, statistically and from a management point-of-view, it does not give a clear representation of the actual progress of the company. If we take the net revenues from sales, for example, this may point out during a certain month of the year, February for example, extremely high levels and could show a spectacular increase in overall sales. Nothing could be more false: it only records payments that were not made during December and the pre-holiday season and that were left for after the holidays. In this sense, the company could have actually sold nothing in February, but only counted the payments made for sales in December.
As such, if we look at this previous example, we may conclude that the cash method, while reflecting the cash situation in the company, does not reflect the evolution and the actual state of the business and the company.
Following the reasoning presented previously, the accrual methodology has two distinct advantages over the cash method. First of all, it "is more accurate in terms of net income." Indeed, at any given time, you are able to evaluate overall net income provided by the company's operations.
Second of all, it is "more realistic for measuring business performance." As I have previously discusses, the accrual method lets a manager analyze and decide on the actual performances of the company. In this sense, if he were to look in December over the accounting books, he would be able to see the actual sales figures, as the company had produced them the respective month.
In general, companies that have gross annual sales exceeding $5 million are recommended to use the accrual methodology. Indeed, we are entitled to believe that in large companies, operating large revenues and expenses, it is critical to know and record how the business is evolving. Additionally, any miscalculations could prove fatal. On the other hand, businesses with significant inventories are also inclined towards accrual methods.
Cash accounting is generally used by small businesses that are in the first year of business. The explanation for this is quite simple. The cash method is quite easy to use and extremely intuitive: whenever you pay money or you receive money, you...
Another benefit is somewhat the reverse of what I have previously mentioned when discussing the accrual method: you can deduct taxes by recording the income the following fiscal year, when it is actually received.
On the other hand, in order "to have accurate accounting information that can be used to make important business decisions" the accrual accounting method is generally recommended. As I have described previously, recording the income and expenses as they produce and are contracted ensures a clear picture about the level of expenses and revenues at a certain period.
Most companies have therefore adopted nowadays the accrual methodology. The complex economical environment in which they evolve and operate has turned this into a necessity.
Bibliography
1. Klinefelter, Danny; McCorkle, Dean (2003). Financial Management: Cash vs. Accrual Accounting. Agricultural Communications, the Texas a&M University System. On the Internet at http://trmep.tamu.edu/cg/factsheets/rm5-16.html
2. Cash vs. Accrual Accounting (April 2000). On the Internet at http://www.inc.com/articles/2000/04/19194.html
3. Cash vs. Accrual Accounting (April 2000). On the Internet at http://www.inc.com/articles/2000/04/19194.html
4. Cash vs. Accrual Accounting (2004). Business Owner's Toolkit. On the Internet at http://www.toolkit.cch.com/text/P06_1340.asp
Cash vs. Accrual Accounting (2004). Business Owner's Toolkit. On the Internet at http://www.toolkit.cch.com/text/P06_1340.asp
Cash vs. Accrual Accounting (April 2000). On the Internet at http://www.inc.com/articles/2000/04/19194.html
Klinefelter, Danny; McCorkle, Dean (2003). Financial Management: Cash vs. Accrual Accounting. Agricultural Communications, the Texas a&M University System. On the Internet at http://trmep.tamu.edu/cg/factsheets/rm5-16.html
Cash vs. Accrual Accounting (April 2000). On the Internet at http://www.inc.com/articles/2000/04/19194.html
Zall, Milton (June 2001). Accounting: Cash vs. Accrual. On the Internet at http://www.wconline.com/CDA/ArticleInformation/features/BNP__Features__Item/0%2C3299%2C28259%2C00.html
