Definition: What Is Accrual Accounting?

Understanding how money moves through your business isn’t just about watching your bank balance—it’s about knowing when income is earned and expenses are incurred. That’s where accrual accounting comes in.

Accrual Accounting Definition

Accrual accounting (also called the accrual method of accounting) records income when it’s earned and expenses when they’re incurred—not when the cash actually changes hands.

In other words, if you send an invoice today but don’t get paid until next month, accrual accounting still records that sale today. Likewise, if you receive a bill for services this month but pay it next month, the expense is recorded when you receive the bill.

Why It Matters for Small Business Owners

Understanding and using the accrual method gives you a much more accurate picture of your business’s financial health.

Key benefits include:

• Better decision-making: You’ll see your true profits and expenses for each period, not just cash flow.

• Compliance and credibility: Many lenders, investors, and tax authorities prefer or require accrual accounting because it aligns with Generally Accepted Accounting Principles (GAAP).

• Smoother growth transitions: As your business expands, the accrual method becomes essential for managing accounts receivable, accounts payable, and financial forecasting.
  

Common Examples and Use Cases

Here are a few real-world examples of accrual accounting in action:

• Invoicing clients: You complete a consulting project in October and send an invoice. Under the accrual method, you record the revenue in October—even if payment arrives in November.

• Paying vendors: You receive an equipment bill dated December 15, but don’t pay until January 10. The expense still belongs to December.

• Prepaid services: You pay a 12-month insurance premium up front. You record one-twelfth of the cost each month as the benefit is “used.”
  

These entries help match income and expenses to the correct period, providing a truer snapshot of business performance.

Related Terms and Common Misconceptions

• Cash Basis Accounting: Unlike accrual accounting, the cash basis records income and expenses only when money is received or paid. It’s simpler but less accurate for larger or inventory-based businesses.

• Accounts Receivable / Accounts Payable: These are the building blocks of accrual accounting—tracking money owed to you and money you owe others.

• GAAP (Generally Accepted Accounting Principles): The accrual method is the foundation of GAAP standards in the U.S.
  

Common misconception: Some small business owners think accrual accounting is “too complicated.” In reality, modern accounting software automates most of these entries—and the payoff in clarity is huge.

Tips for Applying Accrual Accounting in Your Business

Here’s how to start using or improving your accrual accounting system:

1. Use accounting software like QuickBooks or Xero—most can automatically record accrual entries.

2. Work with a professional bookkeeper who understands how to properly record revenue and expenses under the accrual method.

3. Reconcile monthly to ensure invoices, bills, and payments match up with your general ledger.

4. Review financial statements regularly—especially your profit and loss statement and balance sheet—to identify timing mismatches.

5. Consult your tax advisor before switching from cash to accrual accounting, as it can affect tax timing and compliance.
   

For hands-on support setting up or maintaining your accrual accounting system, visit Development Theory's Bookkeeping & Payroll Services page.