Is the Matching Principle Right for Your Small Business?
When it comes to running a small business, few things are as important (or potentially as frustrating) as keeping accurate financial records. Implementing effective methods for recording what money is coming in and going out lets you keep a finger on the pulse of your financial health. But what accounting system is best for your business?
The matching principle is part of the accrual-basis accounting system, establishing a cause-and-effect relationship between revenue and expenses. Using it is like balancing your checkbook every time you make a deposit or write a check to pay for an expense. Many people who own small businesses find using the matching principle to be an easy way to keep track of their finances through Skynova's accounting software.
In this guide, we'll unpack the matching principle concept, its benefits, and give you some concrete examples so you can decide if it's right for you and your small business.
What Is the Matching Principle?
The matching principle is a key element of the accrual basis of accounting and adjusting entries, in which a business matches expenses with its related revenues for a given accounting period. Accrual accounting dictates that these related revenues and expenses are recorded when they take place, rather than when money changes hands.
Expenses noted but not yet paid are called accrued expenses. The matching concept ensures that you record both revenue and any related accrued expenses together. By accounting for the expense at the time that it's incurred and not when it's paid, you have a more up-to-date picture of your business's financial situation because you're already setting aside the money you'll be spending to cover expenses.
For anyone who's ever balanced a checkbook for their personal finances, the idea behind the matching principle may seem easy and obvious. But when you're running a small business, it's quite easy to lose track of how much money you've spent versus how much you've made. Using the matching principle for your small business accounting reflects the real-world fact that your business doesn't just make money — it also spends it. If you don't account for your expenses with your revenue, you run the risk of assuming you have more money than you actually do.
Businesses operating under a false assumption of how much money they have tend to run up debt, which can be a quick way to see your business fail. This is why the matching principle and the accrual basis of accounting are part of the Generally Accepted Accounting Principles (GAAP). These principles encompass all approved standard accounting methods and processes.
What Is Accrual Accounting?
The accrual method of business accounting is an accounting system where your business's revenue and expenses are recorded when each takes place, rather than when actual payment is made or received. The matching principle simply states that related revenue and expenses should be recorded together to reflect the direct correlation between money in and money out.
An alternate accounting system is called cash accounting or cash-basis accounting, which states that you should record your business's revenue and expenses at the time of payment when cash changes hands.
Either of these accounting systems can prove a good fit for your business, and either will help you generate accurate and up-to-date cash flow statements. The biggest key to any accounting system is consistency and accuracy in reporting, so once you choose an accounting system, just make sure you stick with it.
What Is the Difference Between the Matching Principle and the Revenue Recognition Principle?
The revenue recognition principle, another pillar of accrual accounting, states that a business records revenue when earned, not when that money is paid. You can note, for example, the money you'll receive from a large sale of goods to a customer while you're still filling the order. Even though you don't yet have the money from that customer, you recognize that the revenue from this sale is imminent. This balance of money due is called the accounts receivable money.
The matching principle states that you must record expenses associated with any revenue for the same time period, regardless of whether that money has been paid out. Together, the revenue recognition principle and the matching principle make up the core pillars of accrual accounting: You recognize incoming revenue and match it with associated expenses.
Using both accounting concepts ensures a more balanced sense of your net income, or the money you have left after deducting expenses. Using only the revenue recognition principle could be problematic if you struggle with maintaining a budget or making impulse purchases for your business. Accounting for expenses and income by using the matching principle with the revenue recognition principle means you're far less likely to spend money you need to pay for upcoming expenses.
What Are the Benefits of the Matching Principle?
The biggest benefit of the matching principle is that it allows you to create a clear and balanced picture of your business's overall financial health. To go back to the checkbook example, recording expenses tied to revenue is like recording money deposited and checks written in the same balance book. You see what money you're putting in and what money will be taken out when the checks you write are cashed. When a check is actually debited from your account, for instance, you've already accounted for that transaction; thus, you're not left with less money than you thought.
A potential drawback or challenge of using the matching principle arises when there's no clear relationship between a revenue and its expense, in which case, you must make estimates to project that relationship. For example, if a business pays for a billboard advertisement space, it will be difficult to associate any revenue driven in directly from that single sign. You can look back over a given time frame to see if you had an increase in revenue and estimate how much may have come from the sign, but you won't be able to connect that revenue directly to the expense.
Examples of the Matching Principle
Knowing how accounting principles work makes it easier to understand why they matter to you as a business owner. Below are some concrete examples of the matching concept to visualize how it might look on the ground for your small business.
Documenting expenses using the matching principle organizes the costs of running your business in a way that lets you assess where your dollars go and why.
For example, if you pay a 10% commission to your sales representatives at the end of each month and your business sees $50,000 in sales for December, you'll pay your sales reps $5,000. While they won't receive that pay until January, recording this commission expense in December (when you actually see that sales revenue come in) lets you immediately see how much you're profiting after those expenses are deducted.
Another example on a smaller level: If your business sells handmade scarves, matching the sale of all scarves sold in a month with the cost of the yarn to make them shows how much you profit selling the scarves in relation to how much you spend to make them. The matching principle matches sales revenue with the cost of goods sold (COGS) so you can see the direct relation between money spent and money made for each product offered.
Depreciation is the loss in value of a business's property or assets over time, usually the period of its serviceable use (called its useful life or service life). Accounting for this depreciation over the course of an asset's useful life is one way for businesses to offset the initial expense of purchasing the asset and has possible tax benefits, as well.
Using the matching principle, depreciation expenses are estimated through what's called a systematic allocation. Calculating just how much to note as a depreciation expense involves assessing just how long an asset's useful life will be and dividing the initial cost of the asset accordingly.
If you purchase a company vehicle for $20,000 and set the useful life as 10 years, for instance, you'll make a systematic allocation of $2,000 every year for those 10 years. This expense will be matched with any value that the vehicle adds for each accounting period — an example of which might be the revenue that a sales representative brought in by driving to various conferences or industry events.
Accounting for employee wages using the matching principle dictates that you note the wages as an expense during the period in which your employees worked and not the date you pay them. Let's say your employees are paid every two weeks, but a pay period runs from Dec. 29 to Jan. 11. You'll record the wages allotted to each employee through the end of December under December's expenses and the wages for January under January's.
Even though the hours worked fall under the same pay period and will be paid out in a single paycheck, the matching principle dictates that the hours worked in December will be separated because the following month is a separate reporting period. When the divide falls between years, as a period crossing from December into January does, you'll record the wage expense for December for the year that's ending, even though payment is made the following year.
As with wages, sales commission expenses and other employee-related costs to your small business will be recorded during the period in which they're earned and not when they're paid when using the matching principle. Should you pay an employee a $2,000 bonus for their excellent work last quarter, for instance, you'll record that money as an expense for the last quarter and not the current one even though you're paying out the bonus now.
The matching principle is about balancing revenue with expenses — a plus with a minus. In this instance, the plus is your employee's hard work, which benefited your business, and the minus is the bonus you grant them as a result. There is a direct relationship between the two, so they must be recorded as occurring together inside the same time period.
Let Skynova Help You Manage All of Your Small Business Financial Statements
Strong accounting practices equal success for your small business. Many businesses fail because they don't keep track of how much money they're spending or earning as well as they should.
The matching principle is a core element of accrual-basis accounting because it forces you to account for every business expense on a monthly, quarterly, and yearly basis. Skynova's business accounting software helps you track those expenses with ease, setting you and your business up for success now and in the future.
Your Skynova account keeps all of your financial statements organized and easy to access. From tracking expenses to generating financial reports, our many templates and software products streamline your small business's accounting processes by making it easy to track your expenses.
You don't have to be frustrated the next time you need to deal with your small business's accounting or financial statements: Use Skynova and get it done.
Notice to the Reader
This and other Skynova business accounting articles are meant to be informative and used as general guidelines. Not all content will apply to your specific situation. Please consult with a business accounting professional to ensure your small business adheres to current financial accounting standards and practices.