What Are Accruals?

Accruals are revenues earned or expenses incurred that impact a company’s net income on the income statement, although cash related to the transaction has not yet changed hands. Accruals also affect the balance sheet, as they involve non-cash assets and liabilities.

For example, if a company has performed a service for a customer, but has not yet received payment, the revenue from that service would be recorded as an accrual in the company’s financial statements. This ensures that the company’s financial statements accurately reflect its true financial position, even if it has not yet received payment for all of the services it has provided.

Accrual accounts include, among many others, accounts payable, accounts receivable, accrued tax liabilities, and accrued interest earned or payable.

Understanding Accruals

An accrual is a record of revenue or expenses that have been earned or incurred, but have not yet been recorded in the company’s financial statements. This can include things like unpaid invoices for services provided, or expenses that have been incurred but not yet paid. Accruals are important because they help to ensure that a company’s financial statements accurately reflect its true financial position, even if it has not yet received payment for all of the services it has provided or paid all of its bills.

In accrual-based accounting, revenue is recognized when it is earned, regardless of when the payment is received. This means that if a company provides a service to a customer in December, but does not receive payment until January of the following year, the revenue from that service would be recorded in December, when it was earned. Similarly, expenses are recorded when they are incurred, regardless of when they are paid. For example, if a company incurs expenses in December for a service that will be received in January, the expenses would be recorded in December, when they were incurred.

The Accrual Method of Accounting

Accruals and deferrals are the basis of the accrual method of accounting, the preferred method by generally accepted accounting principles (GAAP). Using the accrual method, an accountant makes adjustments for revenue that has been earned but is not yet recorded in the general ledger and expenses that have been incurred but are also not yet recorded. The accruals are made via adjusting journal entries at the end of each accounting period, so the reported financial statements can be inclusive of these amounts.

The use of accrual accounts greatly improves the quality of information on financial statements. Before the use of accruals, accountants only recorded cash transactions. Unfortunately, cash transactions don’t give information about other important business activities, such as revenue based on credit extended to customers or a company’s future liabilities. By recording accruals, a company can measure what it owes in the short-term and also what cash revenue it expects to receive. It also allows a company to record assets that do not have a cash value, such as goodwill.

In double-entry bookkeeping, the offset to an accrued expense is an accrued liability account, which appears on the balance sheet. The offset to accrued revenue is an accrued asset account, which also appears on the balance sheet. Therefore, an adjusting journal entry for an accrual will impact both the balance sheet and the income statement.

Recording Accruals on the Income Statement and Balance Sheet

To record accruals on the balance sheet, the company will need to make journal entries to reflect the revenues and expenses that have been earned or incurred, but not yet recorded. For example, if the company has provided a service to a customer but has not yet received payment, it would make a journal entry to record the revenue from that service as an accrual. This would involve debiting the “accounts receivable” account and crediting the “revenue” account on the income statement.

On the other hand, if the company has incurred expenses but has not yet paid them, it would make a journal entry to record the expenses as an accrual. This would involve debiting the “expenses” account on the income statement and crediting the “accounts payable” account.

Examples of Accruals

Let’s look at an example of a revenue accrual for a utility company.

Accounts Payable

An example of an accrued expense for accounts payable f could be the cost of electricity that the utility company has used to power its operations, but has not yet paid for. In this case, the utility company would make a journal entry to record the cost of the electricity as an accrued expense. This would involve debiting the “expense” account and crediting the “accounts payable” account. The effect of this journal entry would be to increase the utility company’s expenses on the income statement, and to increase its accounts payable on the balance sheet.

Another example of an expense accrual involves employee bonuses that were earned in 2019, but will not be paid until 2020. The 2019 financial statements need to reflect the bonus expense earned by employees in 2019 as well as the bonus liability the company plans to pay out. Therefore, prior to issuing the 2019 financial statements, an adjusting journal entry records this accrual with a debit to an expense account and a credit to a liability account. Once the payment has been made in the new year, the liability account will be decreased through a debit, and the cash account will be reduced through a credit.

Accounts Receivable

The utility company generated electricity that customers received in December. However, the utility company does not bill the electric customers until the following month when the meters have been read. To have the proper revenue figure for the year on the utility’s financial statements, the company needs to complete an adjusting journal entry to report the revenue that was earned in December.

It will additionally be reflected in the receivables account as of December 31, because the utility company has fulfilled its obligations to its customers in earning the revenue at that point. The adjusting journal entry for December would include a debit to accounts receivable and a credit to a revenue account. The following month, when the cash is received, the company would record a credit to decrease accounts receivable and a debit to increase cash.

Accrued Interest

Another expense accrual occurs for interest. For example, a company with a bond will accrue interest expense on its monthly financial statements, although interest on bonds is typically paid semi-annually. The interest expense recorded in an adjusting journal entry will be the amount that has accrued as of the financial statement date. A corresponding interest liability will be recorded on the balance sheet.

The Bottom Line

Accruals impact a company’s bottom line, although cash has not yet exchanged hands. The accrual method of accounting is the preferred method according to GAAP, and involves making adjustments for revenue that has been earned but is not yet recorded, and expenses that have been incurred but are not yet recorded, by making adjusting journal entries at the end of the accounting period. Accruals are important because they help to ensure that a company’s financial statements accurately reflect its actual financial position.

What Is Accounts Receivable Financing?

Accounts receivable (AR) financing is a type of financing arrangement in which a company receives financing capital related to a portion of its accounts receivable. Accounts receivable financing agreements can be structured in multiple ways usually with the basis as either an asset sale or a loan.

Understanding Accounts Receivable Financing

Accounts receivable financing is an agreement that involves capital principal in relation to a company’s accounts receivables. Accounts receivable are assets equal to the outstanding balances of invoices billed to customers but not yet paid. Accounts receivables are reported on a company’s balance sheet as an asset, usually a current asset with invoice payment required within one year.

Accounts receivable are one type of liquid asset considered when identifying and calculating a company’s quick ratio which analyzes its most liquid assets:

Quick Ratio = (Cash Equivalents + Marketable Securities + Accounts Receivable Due within One Year) / Current Liabilities

As such, both internally and externally, accounts receivable are considered highly liquid assets which translate to theoretical value for lenders and financiers. Many companies may see accounts receivable as a burden since the assets are expected to be paid but require collections and can’t be converted to cash immediately. As such, the business of accounts receivable financing is rapidly evolving because of these liquidity and business issues. Moreover, external financiers have stepped in to meet this need.

The process of accounts receivable financing is often known as factoring and the companies that focus on it may be called factoring companies. The best factoring companies will usually focus substantially on the business of accounts receivable financing but factoring in general may be a product of any financier. Financiers may be willing to structure accounts receivable financing agreements in different ways with a variety of different potential provisions.​

Structuring

Accounts receivable financing is becoming more common with the development and integrations of new technologies that help to link business accounts receivable records to accounts receivable financing platforms. In general, accounts receivable financing may be slightly easier for a business to obtain than other types of capital financing. This can be especially true for small businesses that easily meet accounts receivable financing criteria or for large businesses that can easily integrate technology solutions.

Overall, there are a few broad types of accounts receivable financing structures.

Asset Sales

Accounts receivable financing is typically structured as an asset sale. In this type of agreement, a company sells accounts receivable to a financier. This method can be similar to selling off portions of loans often done by banks.

A business receives capital as a cash asset replacing the value of the accounts receivable on the balance sheet. A business may also need to take a write-off for any unfinanced balances which would vary depending on the principal to value ratio agreed on in the deal.

Depending on the terms, a financier may pay up to 90% of the value of outstanding invoices. This type of financing may also be done by linking accounts receivable records with an accounts receivable financier. Most factoring company platforms are compatible with popular small business bookkeeping systems such as Quickbooks. Linking through technology helps to create convenience for a business, allowing them to potentially sell individual invoices as they are booked, receiving immediate capital from a factoring platform.

With asset sales, the financier takes over the accounts receivable invoices and takes responsibility for collections. In some cases, the financier may also provide cash debits retroactively if invoices are fully collected.

Most factoring companies will not be looking to buy defaulted receivables, rather focusing on short-term receivables. Overall, buying the assets from a company transfers the default risk associated with the accounts receivables to the financing company, which factoring companies seek to minimize.

In asset sale structuring, factoring companies make money on the principal to value spread. Factoring companies also charge fees which make factoring more profitable to the financier.

BlueVine is one of the leading factoring companies in the accounts receivable financing business. They offer several financing options related to accounts receivable including asset sales. The company can connect to multiple accounting software programs including QuickBooks, Xero, and Freshbooks. For asset sales, they pay approximately 90% of a receivables value and will pay the rest minus fees once an invoice has been paid in full. 

Loans

Accounts receivable financing can also be structured as a loan agreement. Loans can be structured in various ways based on the financier. One of the biggest advantages of a loan is that accounts receivable are not sold. A company just gets an advance based on accounts receivable balances. Loans may be unsecured or secured with invoices as collateral. With an accounts receivable loan, a business must repay.

Companies like Fundbox, offer accounts receivable loans and lines of credit based on accounts receivable balances. If approved, Fundbox can advance 100% of an accounts receivable balance. A business must then repay the balance over time, usually with some interest and fees.

Accounts receivable lending companies also benefit from the advantage of system linking. Linking to a companies accounts receivable records through systems such as QuickBooks, Xero, and Freshbooks, can allow for immediate advances against individual invoices or management of line of credit limits overall.

Underwriting

Factoring companies take several elements into consideration when determining whether to onboard a company onto its factoring platform. Furthermore, the terms of each deal and how much is offered in relation to accounts receivable balances will vary.

Accounts receivables owed by large companies or corporations may be more valuable than invoices owed by small companies or individuals. Similarly, newer invoices are usually preferred over older invoices. Typically, the age of receivables will heavily influence the terms of a financing agreement with shorter term receivables leading to better terms and longer term or delinquent receivables potentially leading to lower financing amounts and lower principal to value ratios.

Advantages and Disadvantages

Accounts receivable financing allows companies to get instant access to cash without jumping through hoops or dealing with long waits associated with getting a business loan. When a company uses its accounts receivables for asset sales it does not have to worry about repayment schedules. When a company sells its accounts receivables it also does not have to worry about accounts receivable collections. When a company receives a factoring loan, it may be able to obtain 100% of the value immediately.

Although accounts receivable financing offers a number of diverse advantages, it also can carry a negative connotation. In particular, accounts receivable financing can cost more than financing through traditional lenders, especially for companies perceived to have poor credit. Businesses may lose money from the spread paid for accounts receivables in an asset sale. With a loan structure, the interest expense may be high or may be much more than discounts or default write-offs would amount to.

What Is the Aroon Indicator?

The Aroon indicator is a technical indicator that is used to identify trend changes in the price of an asset, as well as the strength of that trend. In essence, the indicator measures the time between highs and the time between lows over a time period. The idea is that strong uptrends will regularly see new highs, and strong downtrends will regularly see new lows. The indicator signals when this is happening, and when it isn’t.

The indicator consists of the “Aroon up” line, which measures the strength of the uptrend, and the “Aroon down” line, which measures the strength of the downtrend.

The Aroon indicator was developed by Tushar Chande in 1995.

Formulas for the Aroon Indicator


$\begin{aligned} \text{Aroon Up}&= \frac{25-\text{Periods Since 25 period High}}{25} \ast100\\ \text{Aroon Down}&=\frac{25-\text{Periods Since 25 period Low}}{25}\ast100 \end{aligned}$Aroon UpAroon Down​=2525−Periods Since 25 period High​∗100=2525−Periods Since 25 period Low​∗100​

How to Calculate the Aroon Indicator

The Aroon calculation requires the tracking of the high and low prices, typically over 25 periods.

1. Track the highs and lows for the last 25 periods on an asset.
2. Note the number of periods since the last high and low.
3. Plug these numbers into the Up and Down Aroon formulas.

What Does the Aroon Indicator Tell You?

The Aroon Up and the Aroon Down lines fluctuate between zero and 100, with values close to 100 indicating a strong trend and values near zero indicating a weak trend. The lower the Aroon Up, the weaker the uptrend and the stronger the downtrend, and vice versa. The main assumption underlying this indicator is that a stock’s price will close regularly at new highs during an uptrend, and regularly make new lows in a downtrend.

The indicator focuses on the last 25 periods, but is scaled to zero and 100. Therefore, an Aroon Up reading above 50 means the price made a new high within the last 12.5 periods. A reading near 100 means a high was seen very recently. The same concepts apply to the Down Aroon. When it is above 50, a low was witnessed within the 12.5 periods. A Down reading near 100 means a low was seen very recently.

Crossovers can signal entry or exit points. Up crossing above Down can be a signal to buy. Down crossing below Up may be a signal to sell.

When both indicators are below 50 it can signal that the price is consolidating. New highs or lows are not being created. Traders can watch for breakouts as well as the next Aroon crossover to signal which direction price is going.

Example of How to Use the Aroon Indicator

The following chart shows an example of the Aroon indicator and how it can be interpreted.

In the chart above, there is both the Aroon indicator and an oscillator that combines both lines into a single reading of between 100 and -100. The crossover of the Aroon Up and Aroon Down indicated a reversal in the trend. While the index was trending, prior to the reversal, the Aroon Down remained very low, suggesting that the index had a bullish bias. Despite the rally on the far right, the Aroon indicator hasn’t shown a bullish bias yet. This is because the price rebounded so quickly that it hasn’t made a new high in the last 25 periods (at the time of the screenshot), despite the rally.

The Difference Between the Aroon Indicator and the Directional Movement Index (DMI)

The Aroon indicator is similar to the Directional Movement Index (DMI) developed by Welles Wilder. It too uses up and down lines to show the direction of a trend. The main difference is that the Aroon indicator formulas are primarily focused on the amount of time between highs and lows. The DMI measures the price difference between current highs/lows and prior highs/lows. Therefore, the main factor in the DMI is price, and not time.

Limitations of Using the Aroon Indicator

The Aroon indicator may at times signal a good entry or exit, but other times it will provide poor or false signals. The buy or sell signal may occur too late, after a substantial price move has already occurred. This happens because the indicator is looking backwards, and isn’t predictive in nature.

A crossover may look good on the indicator, but that doesn’t mean the price will necessarily make a big move. The indicator isn’t factoring the size of moves, it only cares about the number of days since a high or low. Even if the price is relatively flat, crossovers will occur as eventually a new high or low will be made within the last 25 periods. Traders still need to use price analysis, and potentially other indicators, to make informed trading decisions. Relying solely on one indicator isn’t advised.