The accrual accounting method is more useful than the cash accounting method when a person or company is trying to understand the performance of a business over a specified time period. Under the accrual accounting method, all revenue and expenses are matched together. All revenues are recorded in the period when goods and services are performed, and all expenses are recorded in the period when goods and services are purchased. This method provides a good snapshot of a company’s performance over a specific time period.
For example, with accrual accounting, if a company bills its clients on credit terms, it records its revenue on its income statement in the period when goods or services are performed. If the same company buys goods and services on credit, it records the expenses on its income statement in the period when the goods and services are received or performed. This way, the company accurately shows how much revenue was earned in a period and how many expenses were incurred in a period. Margin analysis, such as an analysis of gross margin, operating margin and profit margin, is more reliable under the accrual accounting method.
Under the cash accounting method, all revenues and expenses are recorded when cash is actually received or cash is actually paid. This method provides an accurate snapshot of a company’s cash flows. For example, if a company bills its clients on credit terms, it records revenue when cash is received and not when goods or services are performed. If a company sells furniture on credit and sells a couch in February but does not receive the money until April, the revenue for goods delivered in February is recorded in April. Again, if a company is strapped for cash or capital-focused, this is a better method.