What is accrual basis accounting?
Accrual basis accounting recognises revenue when it is earned and expenses when they are incurred — regardless of when cash actually moves. It is the standard required by IFRS, US GAAP and TFRS for all but the smallest businesses, because it provides a more faithful representation of economic performance than tracking cash alone.
The two pillars
- Revenue recognition (IFRS 15 / ASC 606): revenue is recognised when performance obligations are satisfied, not when cash is collected. A SaaS subscription paid annually upfront is recognised monthly over the service period.
- Matching principle: expenses are recognised in the same period as the revenue they helped generate. Sales commissions earned on a 12-month contract are amortised over the contract term, not expensed at signing.
Accrual basis vs. cash basis
- Cash basis: simpler — revenue when cash received, expense when paid. Only permitted for very small businesses under most regimes; not GAAP/IFRS-compliant.
- Accrual basis: uses accounts receivable, accounts payable, deferred revenue, accrued expenses to bridge timing gaps between cash and economic activity.
What accrual creates
- Accrued revenue: earned but not yet billed.
- Deferred revenue: cash received before performance — a liability until the obligation is met.
- Accrued expenses: incurred but not yet invoiced or paid.
- Prepaid expenses: paid before the expense is recognised over time.
Why founders should know it
A SaaS business on cash basis looks wildly profitable when annual contracts are signed and wildly unprofitable in renewal-light quarters. Accrual smooths this into the economic reality. Investors require accrual-basis financials in due diligence; cash-basis financials raise immediate questions about the maturity of the finance function.
Do: move to accrual basis as soon as the business has multi-period contracts, prepayments or substantial AR.
Don’t: manage to cash-basis metrics in an accrual business — you will mistake timing for economics and over- or under-react in both directions.