Accrual financial management is one of the two approaches to business accounting for most construction companies and roofing contractors. It’s the practice of recording future expenses and incoming payments that have yet to occur in the real world. These transactions are agreed upon on paper but have yet to be converted into actual transactions.
For instance, if ABC Company builds a roof for Customer XYZ, they will record their service fee when the project is complete, whether or not XYZ made the payment. The payment will enter ABC’s income record as of that moment. Conversely, if ABC practices cash financial management, they will record the amount when XYZ pays their dues, not when they complete the roof.
Hire 24hr Bookkeeper after making an informed decision about accrual financial management.
Is Accrual Financial Management for You?
Before delving into the pros and cons of accrual financial management, let’s see whether you have a choice.
Organizations that abide by the Generally Accepted Accounting Principles (GAAP) are required to follow the accrual accounting method. These large-scale and publicly-listed companies must comply with the rules set forth by the U.S. Securities and Exchange Commission.
Accrual financial management is optional for small-to-medium-sized businesses. Thus, you can decide whether this approach is or isn’t for you after deliberating over its upsides and downsides.
The Upsides of Accrual Financial Management
Let’s start with the obvious: GAAP compliance. The accrual approach isn’t every company’s cup of tea, but most adopt it regardless, as they don’t consider it a matter of choice. If you plan on growing your business in the near or distant future, start with accrual financial management to comply with GAAP and avoid any issues when going public.
Even if you’re not planning to go public, the larger your business gets, the higher your chances of requiring the accrual approach to finances. Getting used to it sooner rather than later can be suitable for the following reasons.
It’s More Honest
We won’t go into the heated debate around the transparency of both approaches. The advocates for cash financial management believe it to be more honest because it only shows transactions as they happen.
On the other hand, those who support accrual financial management think it’s more honest because it gives a more accurate picture of a company’s financial health. The other side argues that the pending inflow/outflow may never happen, but we’ll leave that for a different blog.
It Aids Future Planning
Accrual financial management helps roofing companies plan for the future by reflecting cash flow as it should be instead of what it is at a given moment. Let us explain.
For instance, Company ABC expects to make a large payment on a construction project but has not yet made it for one reason or another. While the money is in their business checking account, they won’t know it’s there because their accrual-based books will show the money has already left the account.
If Company ABC had relied on cash financial management, they wouldn’t have had access to this bigger picture. They would only know how much they have in their account, not how much they have in the account after they take away their dues.
With accrual financial management, you can evaluate your cash flow and plan to avoid a crisis and shortages well in advance.
It’s Clearer About Revenue and Expenses
Accrual financial management clears the air around your revenue and expenses. If the relationship between these two transactions is clear, you can better understand your cash flow. If you have a better picture of your cash flow, you can plan for the crises we just mentioned and peak construction seasons. You’ll need to invest more with projects coming in left and right.
If you don’t have that kind of money, you may need to seek out a loan. All of this requires prior planning, which is only possible if you know where your revenue stands in relation to your expenses.
The Downsides of Accrual Financial Management
If you’re switching to the accrual approach when you’ve used its counterpart for years, let us warn you: Choppy waters ahead. Most construction companies hire bookkeeping services to set it up because it’s a multi-tiered system that takes years to implement when they do it on their own.
Below are some more disadvantages of this approach.
Not for Negative Cash Flow
Accrual financial management is optional for smaller businesses. However, companies with negative cash flow must only take this approach once they are on solid ground. Growing a business could cause negative cash flow; if that’s the case with your company, let it pass before switching to the accrual approach.
Difficult to Understand and Implement
Cash management is simple, especially during tax season. Filing tax returns is further complicated by accrual financial management. Its GAAP guidelines make it unnecessarily complicated and positively riddled with rules you must follow to avoid an audit. If you like it straightforward and easy to understand, go for the cash approach. Record income and expenses as they occur instead of during a set period.
High Fraud Risk
The fraud risk is high for construction companies that prefer “keeping it in the family.” If your company has an in-house accounting department, your accrual financial management approach may increase the risk of internal fraud.
Here’s what you can do to reduce this risk:
- Do your homework about the accrual approach.
- Understand the risks.
- Gauge your vulnerabilities.
If you suspect internal fraud despite taking the above steps, entrust us with your construction bookkeeping tasks. Recruit financial management services for housebuilders to plug the holes in your accounting strategy and spare the expenses associated with in-house bookkeeping. Let us handle workflow management, monthly bookkeeping, software integration, and more.
Schedule your consultation today.
