Accrual Accounting and Adjusting Entries

What would a company do that followed cash-basis accounting? This question is just one more reason why accrual-basis account is the preferred method of accounting. A company that pre-paid their insurance in cash-basis accounting would take the entire expense when they sent cash to the insurance company. Ultimately the transaction would look like this: Debit insurance expense and credit cash. The expenses in that month would be overstated. Companies that constantly overstated their expense would have a hard time making sound financial decisions. This is also true for external users. If they are looking to invest in a company that overstated their expenses and under stated their assets, the external users might underestimate the amount of money they could lend to the company providing a cash shortage later in the year for a company. Not have enough cash to operate properly is why a lot of businesses are forced to close their doors.