Why do we use and why does our understanding accrual accounting matter?
In subsequent write-ups, I will elaborate on why these details matter, but for now, the focus is on the details. Hint: it is not a love a rules but on an accurate assessment of the intrinsic value of the firm. This has implications for all sorts of business application, including investing, IPOs, lending and venture capital.
The goal of the income statement is to accurately report what happened in a given period, which immediately exposes the limitations of a cash-based system of recognition. The exception would be if the transactions were very small, and always limited to cash sales only, such as a food vending stand. But even then, if anything made available for sale was purchased on credit, it would skew the earnings based on when the purchases on and payments against credit were made.
The timing of revenue recognition is also important. But as we have seen over and over, revenue (that has been booked to a receivable [more about this later]) is only as good as the probability of its being collected. Think of the present state of our banking system. That is why we pay attention to numbers such as day sales outstanding (how long it takes to collect) in the accounts receivable figures. Our current climate and understanding of credit risk will have implications on strategic business planning for years to come.