For any on-the-rise CPG brand, transitioning from cash to accrual accounting is more than a bookkeeping change—it’s a crucial step toward financial maturity. Making the shift not only increases efficiency and accountability, it casts a favorable light for investors, acquirers and regulators.
Consider a common scenario: You ship a large order to a retailer with 60-day payment terms while simultaneously purchasing raw materials for your next production run. Under cash accounting, the books show significant expenses without corresponding revenue for two months, distorting profitability. Accrual accounting eliminates this issue by recording revenue and expenses when they occur, rather than waiting until cash changes hands.
Cash accounting recognizes revenue and expenses only when money is exchanged, making it simple but less reflective of a business’s financial health. Accrual accounting, in contrast, records transactions when they occur and offers a clearer financial picture.
A company might appear profitable one month simply by delaying bill payments, even if it’s struggling financially. This method also limits strategic decision-making, as business leaders can’t accurately track profitability trends or manage cash flow.
Moreover, cash accounting can lead to compliance risks. Many regulatory bodies require accrual accounting for businesses above a certain size or those managing inventory. Using cash accounting when accrual is required can result in compliance issues, tax inaccuracies or financial misstatements.
Accrual accounting is essential for CPG brands, particularly those scaling, seeking capital or needing visibility into gross margin. Here’s a breakdown of the key issues:
Accrual accounting helps CPG brands gain accurate visibility into gross margins by matching revenue with associated cost of goods sold. Additionally, tracking accounts receivables and payables makes it easier to manage working capital to avoid liquidity issues
Accrual accounting also sets the stage to secure institutional funding, as investors and lenders require accrual-based financials for accurate assessments.
The move to accrual accounting requires careful planning and implementation. While the end goal is comprehensive accrual-based reporting, successful transitions typically begin with fundamental changes to revenue and cost recognition.
Start by establishing clear policies for revenue recognition. In the CPG world, this means recording sales when products ship, not when payment arrives. This change requires new processes for tracking accounts receivable and managing customer payment terms. You'll need to document how you'll handle various scenarios such as returns, promotional discounts and product movement in different sales channels.
Next, focus on inventory management and cost recognition. This step often presents the biggest challenge for CPG brands because it requires tracking raw materials, work-in-progress and inventory values for finished goods. You'll need systems to calculate accurate unit costs for each SKU and procedures for matching the cost of goods sold with related revenue.
Many brands face challenges during this transition. Here are key mistakes to avoid:
Successful implementation requires operational and accounting workflows to evolve. While sophisticated enterprise resource planning software like FishBowl and Cin7 can help, many brands start with well-designed spreadsheets before graduating to more comprehensive solutions.
No matter what tools you have at hand, your team will need training to understand new protocols and responsibilities. Establish standard operating procedures for invoicing, expense reporting and inventory tracking to ensure consistency. Clearly communicate how accrual accounting impacts staff’s varying roles and processes. Sales teams need to understand revenue recognition, for example, while warehouse managers must accurately track inventory. Last but not least, hold regular financial check-ins to assess progress and refine processes.
Rather than conducting an abrupt overhaul, a phased approach ensures smoother implementation:
Switching to accrual-based financial reporting doesn’t necessarily mean changing tax reporting methods. Many businesses can maintain cash-basis tax reporting while using accrual accounting for financial statements.
If transitioning to accrual for tax purposes, filing IRS Form 3115 (Application for Change in Accounting Method) may be required. Businesses above certain revenue thresholds or managing inventory may be mandated to use accrual accounting for tax reporting.
Additionally, business owners should consider timing differences that may impact taxable income. Revenue is recognized when earned, not received, which could lead to earlier tax obligations. Likewise, expenses are deducted when incurred rather than when paid, affecting short-term cash flow. A CPG-focused accounting consultant can help navigate these complexities.
The transition to accrual accounting is a critical milestone for growing CPG brands. While it requires effort, the financial clarity it provides is invaluable for long-term success. Whether you’re preparing for a funding round or improving operational visibility, now is the time to build more sophisticated financial processes.
Beyond compliance, accrual accounting sets the foundation for sustainable growth, enabling smarter pricing, inventory management and strategic investment decisions. Taking a structured approach to implementation will ensure a smoother transition and position your brand for financial success.