Both small and large businesses alike need to understand proper business accounting methods and what they mean for the business. If businesses do not follow correct accounting procedures, fines, penalties, and potential criminal charges might follow.
Whether you use an in-house accounting team or work with the accounting experts at GBL Accounting, you have a choice of what accounting method to use for your business. Here’s the difference between the cash and accrual accounting methods and how you can decide which is right for your business.
Accrual Basis of Accounting
The most commonly used method of accounting is the accrual accounting method. This method records both expenses and earnings as they happen, even if cash does not exchange hands at the time of the expense or revenue recording.
The reason that the accrual basis of accounting is more commonly used than the cash basis of accounting is that expenses and revenue are recorded real-time, which gives businesses a realistic look into how the business is handling its finances.
However, since entries are not recorded as cash is exchanged, it can be more difficult to review cash flow accurately, which can be a major problem for new businesses.
Cash Basis of Accounting
On the other hand, the cash basis of accounting accounts for revenues and expenses as cash is exchanged. For example, when your business pays a vendor for an expense, it is recorded when the payment is made. The same goes for earning revenue. This is a very common basis of accounting or small businesses because it’s easy to understand exactly how much cash is coming into the business as well as going out of the business.
Cash flow is extremely important for any business, but even more so for small businesses that rely on steady cash flow to maintain operating costs. However, it does not account for accounts receivable and accounts payable.
How These Methods Impact Reported Revenues
Each basis of accounting will have different impacts on reported revenues and expenses over a given period of time. Depending on when your customers make payments or you pay for your expenses, the cash basis of accounting may not accurately capture your incoming revenue and outgoing expenses for a given period.
On the other hand, the accrual method accounts for expenses and income as the transaction happens, not as cash exchanges hands. This often gives a more accurate picture of revenues and expenses, but may be a drawback when it comes to taxes. If you make a sale at the end of a calendar year, you owe taxes on that sale, even if you receive the payment at the beginning of the new year.
Choosing the Right Method for Your Business
Choosing the right method of accounting depends on how you want to operate your business and what financial insights matter to you most. While it’s certainly possible to get in-depth insights into all of your financials, as a small business it’s often easier to handle accounting with the cash basis.
By choosing the cash method, your business tracks all incoming and outgoing cash flow as it happens. As your business develops and grows, transitioning to the accrual method of accounting will enable your business to analyse and control complex accounting within your business.
As you can see, there’s a lot to consider when it comes to choosing the right accounting method for your business. At GBL Accountants, we’re ready to help you tackle your business accounting challenges. From choosing the right basis of accounting to navigating business tax, our team will partner with you on every step of your business journey.