Conversion to Accrual

There are two primary ways to handle accounting in your business: cash-based and accrual-based.

Many businesses who do not have a dedicated accountant tend to default to cash-based accounting. In this type of accounting, income and expenses are recorded when they are received or paid; that means you record income based on when money actually hits your account, and you record expenses based on when money is actually taken from your account.

This is a popular method because it’s more simple and easier to implement than accrual-based accounting, but it doesn’t provide as accurate a picture of your company’s financial performance.

In accrual-based accounting, income and expenses are recorded when they are earned or incurred. This means that income records are based on when work is done, regardless of when payment is received, and expense records are based on when you make a purchase, regardless of when you actually pay. 

For example, let’s say you sell a service to someone on a three-month payment plan, where 1/3 of the total cost is due in January, February, and March. In cash-based accounting, you would record each monthly payment in the month the payment is received. In accrual-based accounting, the entire sale would be recorded in your financial statements at the time the sale is made, even though you haven’t been paid in full.

This is considered to provide a more accurate view of your financial performance, because it actually indicates when the money was earned. In cash-based accounting, January, February, and March would all show as having the same amount of income, even if you didn’t make any additional sales the latter two months.

Similarly, let’s say you purchase a new piece of equipment for your business on credit and you will be making monthly payments until it’s paid off. In cash-based accounting, your recurring payments would be recorded in each month they’re made; in accrual-based accounting, the entire total would be recorded in the month you actually made the purchase.

Deciding whether to use accrual- or cash-based accounting for your business will depend on a number of factors, including the size and complexity of your business, the nature of your industry, and the type of information you need for decision-making and reporting purposes.

Here are three things to consider when deciding which type of accounting is right for your business:

• Complexity of your transactions. If you typically don’t have outstanding income or expenses at the end of the month, you may be satisfied with cash-based accounting. If you typically receive payments in installments, or regularly make purchases to be paid on long-term, accrual may be best for you.
• Strategic planning needs. While cash-based accounting can provide an accurate snapshot of your cashflow at any given time, it’s usually not the best option for long-term projections.

• Available resources. Implementing accrual-based accounting can be a complex and challenging process. It’s generally recommended that you consult with a professional before making the move, either through a remote firm like Anne Napolitano Consulting, or by hiring an internal team.

If you’re still not sure whether accrual-based accounting is right for your business, we encourage you to reach out for a complimentary consultation.

Converting your business from cash-based to accrual-based accounting is a large undertaking. Here’s what a typical conversion looks like with Anne Napolitano Consulting:

• First, we’ll assess your transactions to determine which will be affected by the change. This will help us get ahead of any potential challenges or issues.
• Next, we’ll develop an implementation plan. This will give us a timeline and a set of specific steps our team as well as yours will need to take for the transition.
• Once we have a plan in place, we’ll implement any new accounting systems if necessary. This might include migrating your books to a different accounting software.
• We’ll get started on the conversion. We’ll start with your existing financial records, including adjusting financial statements from prior periods, and implement new processes for future accounting.
• When the conversion is done, we’ll make sure you’re trained up on the new processes and you’ll have the option to hire our firm for ongoing accounting and reviews of your books.

This can be a daunting process, and we’d love to take it off your hands!