Switching from cash to accrual accounting can feel like a big leap, but it’s often a smart move for growing businesses. This shift provides a more accurate financial picture and helps align your accounting practices with standard financial reporting. Here’s a step-by-step guide to make the switch simple, with insights on why it matters, how to make it seamless, and when it might be right for you.
Why Switch from Cash to Accrual Accounting?
Before jumping into the “how,” let’s briefly cover the “why.” Cash accounting is straightforward: you record income when cash comes in and expenses when they’re paid out. It’s a great system for smaller or simpler businesses because it tracks actual cash flow. But cash accounting doesn’t capture the whole picture, especially as your business grows and you handle more complex transactions.
Accrual accounting, on the other hand, records income when it’s earned and expenses when they’re incurred, regardless of when cash changes hands. This method gives you a better handle on your financial health since it reflects revenue and expenses related to actual business activities. So, if you’re looking to scale or need a comprehensive view of your financial standing (or if you’re required by law as you grow), accrual accounting may be your best bet.
Step 1: Gather Your Financial Records
To switch to accrual accounting, you’ll first need to collect your existing financial data. This includes all income and expense records, including invoices, accounts receivable, accounts payable, and any outstanding expenses. In cash accounting, you might only have paid or received records, but accrual accounting requires tracking when these transactions took place.
Organizing this data will provide a smooth starting point for the transition. Think of it as setting the foundation—you’ll want clear records of everything you owe and everything you’re owed.
Step 2: Adjust Your Chart of Accounts
The chart of accounts is a list of every account in your financial system, from assets to liabilities, equity, income, and expenses. Cash accounting might have a simpler version of this chart, while accrual requires more detailed tracking.
In accrual accounting, you’ll add accounts like “Accounts Receivable” (money owed to you but not yet received) and “Accounts Payable” (money you owe but haven’t paid yet). Setting these up properly will help you record transactions as they happen, regardless of cash flow timing.
Step 3: Make Initial Adjustments to Your Books
With cash accounting, income and expenses are recorded only when cash changes hands, but for accrual accounting, you’ll need to account for “accrued” income and expenses that have yet to be paid. For example, if you completed a job for a client but haven’t been paid, you’ll record the income as “accounts receivable.” Likewise, if you received goods but haven’t paid the supplier, record it as “accounts payable.”
This adjustment involves going back to your previous records and recognizing revenue or expenses from the dates they occurred, not just when the cash was exchanged. While this process may take some time initially, it’s a critical step in aligning your books with accrual accounting.
Step 4: Consider Software and Professional Help
Switching to accrual accounting can be a challenge, especially if you’ve been using cash accounting for a long time. Many accounting software platforms, like QuickBooks and Xero, allow you to set your system to accrual, making it easier to manage records. These tools automate much of the process, from invoicing to tracking receivables and payables.
Additionally, consulting with an accountant or financial specialist is invaluable. We have amazing accountants and financial advisors at Cooper Norman. They can guide you through setting up the accrual system, ensure your records are accurate, and provide ongoing support to avoid costly mistakes.
Step 5: Keep Track of Your Progress and Adjust
Switching to accrual accounting is not a one-and-done task. Track your progress over the next few months, keeping an eye on any challenges. It’s common to have a few bumps in the road, but with consistent record-keeping and regular checks, you’ll be well on your way to a successful transition.
Ready to Switch?
Switching to accrual accounting is a big step, but the benefits—better financial clarity, improved insights, and meeting business growth needs—make it worthwhile. Whether you handle the change yourself or work with a financial professional, the process will set your business up for success and provide a clearer financial outlook for the long haul. If you have questions or run into any challenges along the way, don’t hesitate to reach out to one of our experienced accountants at Cooper Norman for guidance.