How businesses record due payments and expenses looks different for different companies. There are two methods of recording transactions to be aware of.
Continuing our series of accountancy FAQs, we’re going to be talking about accruals including what they are and who uses them.
What are accruals?
Accruals are a way to track expenses and revenues that haven’t been accounted for yet. It’s sometimes referred to as traditional accounting.
In bookkeeping, you can decide whether to record a transaction either when it was initially made, or when you have received payment for it.
The accrual method in accounting refers to the first way. You record a transaction as soon as the customer makes it, even if they don’t pay for a while.
So, if a business completes a job in March, you would record the revenue in March, even if the client doesn’t pay until April. This is to ensure the company finances show a sale in their accounts in March.
This means that there will be transactions and recorded revenue in a business even if you haven’t received the money yet.
The same thing applies to expenses. If a business is invoiced in June but doesn’t pay until July, the expense is recorded in June when the transaction took place.
Accruals versus cash basis accounting
In addition to accrual based traditional accounting, you may come across cash basis accounting.
Cash basis accounting is where you only log the transaction when the business has received payment. Importantly, you should still have a record of your invoices for credit control reasons.
Cash basis is the preferred method for smaller businesses and is how most businesses start off. It’s particularly suited to service-based businesses and those who get paid upfront.
Should I use accrual or cash-basis accounting?
You can only use the cash basis method if your turnover is £150,000 a year or less. If your turnover is more than this, you will need to switch to the accrual method. It’s also worth noting that only sole traders and partnerships can use cash accounting, limited companies cannot.
The accrual method might even be more beneficial to you on day one, but this will depend on your circumstances. It’s a good option for complicated businesses, or those with high levels of stock.
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.
What accounting records do I need to keep?
Maintaining good bookkeeping records is critical; for your own decision making, for HMRC, and for any financial backers. The accounting method that you use dictates what information must be recorded.
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.
Year-end bank balances, how much you’ve invested in your business over the year, and how much you’ve taken out for your own use should also be recorded.