Good financial statements help you understand the monetary implications of your decisions.  Most new businesses start by using cash based accounting because it is simple and similar to keeping a checkbook.  However, with cash-based accounting, the financial statements only reflect cash inflows and outflows.  They fail to capture important transactions that have no immediate cash effect. A simple example can highlight this issue.  Suppose you have a particularly busy month with higher than usual sales.  Your expenses to support the higher sales will be larger.  You incur many of these expenses such as wages immediately.  However, you may not receive payment for sales for a month or more.  This creates the impression that income is low or negative in high productivity months.  Using a cash based accounting system would mislead you into thinking that the business was suffering, when in fact it was quite prosperous.   

In order to fully understand your current financial situation, you must consider both your future obligations (liabilities) as well as any future payments (receivables) you are due.  This can only be done with accrual accounting.  Having information about future obligations and income will allow you to better manage your cash flow.  You can more easily estimate how much money you can spend (open to buy) without requiring loans or feeling a cash squeeze.  In addition, accrual accounting can give you an accurate picture of the current profitability of a project.  You will be able to tell if a particular project is running over budget in time to take corrective action.  With cash accounting you often don’t know the profitability of a project until it has ended.  In other words, accrual accounting is critical to matching your financial reporting to your business decisions (emulating the business).

Some business are reluctant to use accrual accounting because they believe it will negatively affect them when reporting taxes.  Tax bills will be incurred when sales occur rather than when payment is received.  This common misperception is propagated by people who don’t fully understand financial reporting and accounting systems.  You can easily track financial information using accrual accounting, but still report to the government that you are using a cash accounting system.  Accrual accounting captures all the information a cash system does, plus more.  Therefore, you can still file your compliance (tax) documents using a cash basis accounting system while relying on the accrual system information for managerial decisions.