Cash vs. Accrual Accounting for Small Business
What is the difference between cash and accrual based accounting? Some businesses may choose either cash or accrual based accounting to do their bookkeeping, generate their financial statements and file their tax returns. However, it may be beneficial for business owners to implement a variance of their financial recording between accrual and cash based accounting practices.
What is the Accrual Accounting Method?
Accrual accounting is the process of recording transactions as they occur, regardless if cash is received or paid. This method of accounting is used more often than cash based accounting. Business owners are able to review their accounting records to effectively determine management’s ability to operate a business.
The benefits of Accrual Based Accounting:
1. Sales are recorded as they occur; therefore, it will be easy to determine if they have met their sales quotas. As well they can determine how many days aged their Accounts Receivable are.
2. Purchases can either be recorded when the purchase order is generated or when the invoice is issued from the supplier:
- By recording the purchase transactions on the date of the purchase orders, business owners can align their sales with the corresponding cost of goods sold (beneficial for larger sales and project accounting). Therefore, periodic financial statements can accurately reflect the gross margin of total sales.
- By recording the purchase transactions on the invoice date from the supplier, business owner’s can determine on their own records the number of days aged for each Accounts Payable.
3. Corporate taxes will be calculated on the actual transactions as they occur. Depending on the tax strategy of the business this may or may not be a benefit.
What is the Cash Accounting Method?
Cash accounting involves recording income when it is received and processing payment transactions when it is paid. Unlike the accrual based accounting method, aligning cash receipts (sales) with their corresponding cash payments (cost of goods sold) is more difficult. However, the cash accounting method allows management to monitor their previous monthly cash flow practices from a bird’s eye view.
The following outlines the benefits of Cash Based Accounting:
- Business owners can determine if they were able to afford their day to day operational overhead based on the timing cash receipts were recorded versus the demand of their monthly overhead.
- Based on cash receipts, management can pin point trends in cash flow to schedule cash payments in the future.
- Management could restructure their business plan based on their ability to manage their cash flow from month to month.
For small business owners, it is more beneficial to record their business transactions via the accrual accounting method; however, it is also important for business owners to monitor their operations on the cash accounting method. A suggestion would be to adopt the accrual accounting method for bookkeeping and maintain a check log (cash ledger) that reconciles to the bank balance as a live document.
Several accounting software packages have modules for cash flow management; however, it may require additional analysis. Therefore, using a cash ledger spreadsheet may be beneficial for business owners who experience high volatility in their cash flow. A cash ledger spreadsheet allows small business owners to plan their purchases more effectively with greater flexibility than utilizing their accounting software.
Cash ledger spreadsheets allow users to enter data to plan their cash flow with minimal editing. As well, business owners can strategize multiple scenarios with ease while their financial records (accrual accounting method) remain uncompromised. Business owners should know with confidence their ability to manage their cash flow as well their ability to operate their business. Therefore, consider accrual accounting for your bookkeeping while monitoring your cash flow through a cash ledger spreadsheet; the extra work will pay itself over and over again.