Businesses need to track their expenses. It's how they
ensure they're heading in the right direction, reaching their objectives,
remaining profitable, and sustaining themselves. However, it isn't always easy.
Some examples of these expenses include
- A client receiving a service from a company but has not
yet paid
- Employees accumulating paid time off they haven't used,
which employers must account for
These situations can complicate a business's accounting
process because, technically, money hasn't changed hands yet. Since a business'
finances affect employers and employees differently, accountants rely on
accruals to ensure that a company's financial statements are always accurate.
What are Accruals?
An accrual is a recorded amount businesses still need to pay
or receive. These include accounts receivable and compensations they will
provide their employees. Companies have accruals to ensure they have a
consistent picture of their financial status.
From an employer's point of view, they need accruals to
ensure accurate accounting of their finances. On the other hand, employees
benefit from accruals because it protects them against feeling undervalued and
underpaid.
Accruals for employers
To put this into better perspective, here's an example.
Suppose a client asks a design company for posters and banners in May for an
event in June; the client will pay after the event. Despite not receiving
payment, the design company must produce the marketing collaterals in May.
Since the client technically availed of the design services in May, the design company will include the revenue in their May financial calculations despite receiving the money at the end of June. The money they earned in May is an accrual.
Employers must be aware of a few accruals to sustain their company's financial health.
1. Accounts payable
Accounts payable refer to the money a business owes its
suppliers, vendors, and creditors for goods or services they acquired but
haven't paid for. They typically record these as liabilities in their balance
sheet until they can finally pay them.
For example, suppose a company purchases $10,000 worth of
goods from a supplier on credit. The company will record the amount in its
accounts payable ledger and pay the supplier later according to an agreed-upon
payment term. That said, payment terms typically range from 30 to 90 days.
Managing their accounts payable ledger well allows
businesses to maintain good relationships with suppliers and vendors and
reminds them to pay on time, avoiding interest charges and late fees.
2. Accounts receivable
Accounts receivable refer to the money a business owes its
customers for goods or services sold but have not paid for. Accounts
receivables are recorded as assets until they receive the payment.
For example, suppose a company sells $20,000 worth of goods
to a customer on credit. The company will record the amount as an asset in its
accounts receivable ledger until the customer pays completes paying the total amount
after a specified term.
These accruals help businesses maintain a healthy cash flow
and potentially avoid bad debts or write-offs.
3. Accrued interest
Accrued interest is the interest accumulated on a financial
asset but not yet paid or received, similar to accounts payable and
receivable.
Businesses usually calculate this based on the principal
amount, interest rate, and period when they earned the interest. Depending on
the nature of the accrual, they can then record it as either a liability or an
asset. For instance, accrued interest on a loan is a liability;
on an investment, it's an asset.
Accruals for employees
Depending on your country's labor policies and the stated employee benefits from your contract, you're entitled to a certain number of paid leaves. Your employers have already set aside money for the leaves, regardless of whether you file them. As long as you don't use the leaves you've earned and are entitled to, it represents an accrual in your employer's books.
You need to understand different forms of accruals to
prevent you from feeling undervalued or under-compensated.
1. Vacation accruals
Vacation accruals track the amount of paid time off
employees have earned but have not yet used. Each time an employee works, they
earn a certain amount of vacation time that they can use later. For instance, you
can be entitled to one additional day of vacation leave per month you worked
throughout the year.
Understanding how your vacation accruals work can help you
plan your time off accordingly, ensuring you don't spend less or more than you
earned.
2. Sick Leave accruals
Sick leave accruals track how much paid time off employees
earn to use when they're sick. It's similar to how vacation accruals work,
where you can become eligible to receive a certain number of sick leaves based
on how long you've worked at the company.
Understanding how sick leave accruals work can help
employees comfortably take much-needed time off when they're sick without
worrying about losing their pay.
3. Bonus accruals
Bonus accruals refer to how much money employees can receive
as a bonus. Employees can receive compensation whenever they reach a specific goal
or perform up to a company standard. For example, if an employee is eligible
for a $1,000 bonus for meeting their sales goals, they might accrue a portion
each month they meet their goals.
Being aware of bonus accruals can guide your work toward achieving a goal and help you understand how your employer can compensate you fairly for your above-average performance.
Wrapping Up
Employers need to understand accruals because it allows them
to keep an accurate record of their finances. These records are invaluable for
determining the company's financial health. Failure to consider accruals may
lead to overspending on taxes and mismanaging funds, leading to financial
headaches and business challenges.
However, employers aren't the only ones who need to know
about accruals. Employees must also know about them because it affects
employees too. Understanding accruals lets them know how much compensation an
employee can expect to be entitled to, and misunderstanding can lead to the
employee feeling underpaid and undervalued.
Whether you're an employer or an employee, accruals can
confuse those who aren't fluent in accounting and can be overwhelming to start
learning about. However, it's worth the effort to understand its basics and
importance, regardless of your business affiliation.
