Accrual accounting works fine as a historical snapshot of a business, but as a real-time management tool it's a failure. Dislocated from reality by timing differences and complicated by provisions, accruals, and many rules, it is out of date before publication.
So today, as I read about Puzzle.io, it was a revelation. This start-up has launched an accounting system designed to provide both a meaningful real-time business picture as well as the required financial reports.
At last, managers have a real-time picture that they can use to manage the business. The picture that financial accounting has not provided since its creation about 500 years ago!
Since the invention of double-entry, accrual-based accounting in 1456 progress has been slow. Apart from some innovation in 1494, the next step was 400 years later in 1880 with the introduction of the adding machine!
To make up for its weaknesses as a management tool managerial accounting evolved in the late 18th and early 19th century to meet the needs of companies in the industrial revolution. Filling many, but not all, of the gaps.
Now a few hundred years later in 2023 it is certainly time for change.
The revelation for accrual accounting
Before you read my comments, there are two provisos:
The first is that in my excitement to write this, I have not yet had the time to dig into and fully understand the Puzzle.io system.
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Secondly, I am not being paid nor am I related in any way to the company.
I’m an ageing small business entrepreneur who, for the last 50-odd years, has been in and out of many businesses in various financial and operational roles. During this time often frustrated by the limitations of the financial accounting systems.
The important message today is that every business owner should know how the business support system world is evolving.
It is said that “accounting is the language of business” but what is not said is that it’s the language of the history of a business. To be a useful management tool the accounting system should be a language of the real-time view of the business's financial state.
From what I’ve seen of Puzzle.io this is now happening.
I'm excited by this kind of game-changing innovation as it makes me optimistic about the role of technology in our fast-changing world. And with the acceleration of technological innovation, this is just the start.
Accrual accounting weaknesses for business owners
As I thought about this innovation, it brought to mind some frustrating elements of the existing accrual financial accounting systems as a management tool.
Frustrating weaknesses faced by many business owners today. Flaws that may have contributed to the failure of many businesses in the past?
Records historical data
Accrual accounting records historical financial transactions, with some limited future assumptions, and does not provide any real-time insights into the financial health of a business.
Provides no value to cash flow management
There are timing differences between recording transactions after they have occurred or when they might occur and when the cash is received or paid out. These timing differences makes it impossible for business owners to use the system to manage cash flow.
Limited insights into today and the future
Traditional accrual accounting systems provide no visibility into a business's current or future financial health. As a result, it is of little use for business owners who must make informed decisions and respond quickly to market or business environment changes.
Accounting is seen as a must-do rather than need to have
With all its shortcomings, many business owners see accounting as a cost to meet external compliance. As an inconvenient nuisance rather than a helpful tool.
Complexity and understanding
Traditional accrual accounting systems are a challenge to understand. This is true especially for business owners with no accounting background and neither the time nor inclination to acquire the knowledge.
Lack of flexibility
Accrual accounting systems are structured, inflexible, and restricted by self-imposed and statutory rules.
Time-consuming and time delayed
Traditional accrual accounting systems can be time-consuming, with data entry and record-keeping requiring dedicated resources for processing entries.
Costly and dependent on professional expertise
Installing and running accrual accounting systems requires a cost and expertise, which may be a barrier for small business owners.
No budgeting or forecasting capabilities
Accrual accounting systems need significant manipulation and add-ons to provide a meaningful management tool.
Incompatibility with other systems
Other business systems are required to integrate with the traditional accounting system. This should be the other way around. The accounting system is not the game but the scorecard.
Conclusion
The world of accounting is changing fast.
Accountants and business owners must stay abreast of the innovations as these changes can provide competitive advantages in the early days.
Undoubtedly, innovations in developing a complete integrated financial system still has some way to go. But they are happening, and business owners should involve themselves in this evolution.
With integrated technology many tasks and functions are being modified and integrated. Roles will change, and hopefully with these innovative tools there will be more successful businesses.