Imagine a company completes a job for a client in late March, but the client won’t pay the invoice until May. Should the company’s March financials pretend that work never happened? In the world of accrual accounting, the answer is a resounding no. This system is all about recording revenues and expenses when they are earned or incurred, regardless of when cash changes hands. This leads us to the central question: what is an accrual in accounting?
What is an accrual in accounting, really?
An accrual is simply a record of a revenue or expense that has been earned or incurred but hasn’t been paid for yet. Think of it as an IOU in your financial statements. For revenue, it’s work you’ve done but haven’t billed for (Accounts Receivable). For expenses, it’s something you’ve used, like electricity or employee labor, but haven’t received a bill for yet (Accounts Payable). This method provides a much more accurate picture of your company’s financial health during a specific period.
Why accruals matter for your financial picture
Using accruals moves you beyond simply tracking your bank balance. It allows you to see the true profitability of your business month by month. For instance, if you pay for a full year of insurance upfront, an accrual system would spread that cost over twelve months, showing the expense in the periods it actually relates to. This prevents a single month from looking artificially terrible or amazingly profitable based solely on cash flow timing. It gives you a consistent and realistic view of your operational performance.
Common examples of accruals in action
Let’s make this concept concrete with a few everyday examples. A common revenue accrual is when a web designer finishes a project but hasn’t sent the invoice by the end of the month. They would still record that revenue for the month it was earned. On the expense side, consider wages. If your pay period ends on the 30th but you pay employees on the 2nd of the following month, you need to accrue for those few days of unpaid work. The same goes for utilities used in March but billed in April.
Keeping track of your accruals
Managing accruals might sound complex, but it’s a fundamental bookkeeping task. At the end of each accounting period, you or your accountant will make “adjusting entries” in your general ledger. This involves debiting or crediting the appropriate revenue or expense account and then offsetting it with the corresponding liability (like wages payable) or asset (like accounts receivable). Good accounting software can automate many of these recurring entries, making the process much smoother.
By embracing the accrual method, you shift from seeing just cash movements to understanding the real financial story of your business. It provides a clearer, more reliable foundation for making informed decisions, securing loans, and presenting your financial status to stakeholders.
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