When managing finances, especially for businesses, it’s crucial to understand prepayments and accruals – two key concepts that ensure your accounts reflect the true financial position of your business.
- Prepayments: Prepayments occur when you pay for something in advance, but the benefit or service is received later. For example, imagine you pay for a 12-month insurance policy on 1st October, covering you until 30th September the following year. As of 31st December, only three months of the policy have been “used up.” The remaining nine months’ worth of the payment is considered a prepayment and should be recorded as an asset on your balance sheet.
- Accruals: Accruals are the opposite. These arise when you receive goods or services now, but pay for them later. For instance, let’s say you’ve used electricity for December but won’t receive the bill until January. Even though the bill hasn’t arrived yet, you need to recognise this expense in December. This ensures your accounts reflect the true expense incurred during that period.
Why Does It Matter? Recording prepayments and accruals accurately ensures that your profit and loss account reflects the correct income and expenses for the period, giving you a true picture of your business’s financial health.
Need Help? We calculate prepayments and accruals for many of our clients, but it’s always good to have an understanding of what they are. This knowledge helps you stay on top of your finances and make informed decisions.