What Are Accrued Expenses?
Under accrual accounting, an expense belongs in the period when it is incurred, even if cash goes out later. When employees work the last week of December but payday falls in January, the company has already consumed that labor, so it records the wage expense in December and books an accrued liability for the unpaid amount.
Accrued expenses differ from accounts payable in one key respect: payables arise from supplier invoices that have actually been received, while accruals are recorded before any invoice exists, often based on estimates. Both sit in current liabilities, and analysts frequently see them combined in a line called accrued liabilities or accounts payable and accrued expenses.
How Accrued Expenses Flow Through the Statements
When the expense is accrued, the company debits an expense account on the income statement and credits accrued liabilities on the balance sheet, reducing net income with zero cash impact. On the cash flow statement, the increase in accrued liabilities is added back within working capital changes, so cash flow is unaffected in that period.
When the bill is finally paid, the liability is reversed and cash decreases, with no new expense hitting the income statement. This timing gap is why a growing accrual balance is a source of cash: the company is effectively financing operations with money it owes employees, lenders, and vendors.
Why Accrued Expenses Matter
Accruals are a standard working capital line in financial models, and their movement affects free cash flow projections in DCFs and LBO models. In transaction work, accrued items like unpaid bonuses or accrued interest are also negotiated in the working capital peg or treated as debt-like items that reduce the price a buyer pays.
For interviews, expect a question such as walking through what happens when a company accrues $100 of salaries: pre-tax income falls by $100, net income falls by $75 at a 25 percent tax rate, and cash is actually higher by $25 because the add-back of the accrual exceeds the lost net income. Mastering that mechanic shows genuine command of accrual accounting.
