Cash Basis vs. Accrual Accounting - Which Works Best for Small Businesses

 

Recording cash flow in a small business is of utmost importance, as businesses need a clear indicator regarding how much money is spent and how much is actually being generated by the sales of the products. Cash basis vs. accrual accounting methods are two rivaling contenders for small businesses to keep track of their spendings as well as their earnings. We'll go through how these accounting methods help in recording cash flow, along with their advantages and disadvantages.

Cash Basis Accounting Method

The cash basis accounting method is a very simple way to keep a record of your business' earnings as well as spendings. In cash basis accounting, your bookkeeper will only record the transfer of funds as soon as you receive the cash in hand. For instance, if your business sells a sectional couch for $2,500, under the cash method, your bookkeeper will not log the sale of the sectional before your business gets paid the actual amount in cash. Even if the buyer pays after a few weeks.

Advantages

You won't have to pay taxes on the amount you haven't received yet. Thus, your payable tax will be determined based on the amount your business actually has in your bank account.

The cash basis accounting is a straight-forward and simple way to keep the financial records of your business. As your bookkeeper will only have to log the transfer of money to and from your bank, his bookkeeping job won't be complicated by the payables and receivables.

Disadvantages

The simplicity of cash basis accounting also appears as disadvantage for the very method. Since your bookkeeper doesn't have to keep a record of the payables and receivables, you won't have much idea about how much your business has to send and receive the money.

Another disadvantage of cash basis accounting is its inaccurate depiction of your earnings. You might believe your business is booming, but the amount you are receiving only accounts for the sales that were made in the previous month.

Accrual Accounting Method

Unlike cash basis accounting method, the expenses and earnings of your small business will be recorded on the same day/month the sale of your product happened or you placed an order of the supplies for your business. For example, if a customer purchases a sofa set for $1,500, your bookkeeper would record it as soon as the purchase was finalized by your client, without waiting for him to pay the actual amount in cash in a later month.

Advantages

You will get a more realistic picture of the financial state of your business as you'll know how much you have the payables and receivables.

If your business makes $25 M in sales annually and if your bookkeeper is already logging the financials via Accrual Accounting, he won't have learned anything new.

Disadvantages

Accrual accounting doesn't showcase the actual cash flow to and from your bank. You may have a hard time to endure if your bookkeeper wasn't careful in logging the financials.

Final Analysis

Cash Basis vs. Accrual Accounting methods have their advantages and disadvantages for small businesses. The choice between the two methods depends on the specific needs and circumstances of the business. Small business owners should carefully consider their cash flow patterns, financial goals, and reporting requirements before deciding which method to adopt. Consulting with a small business CPA can also provide valuable guidance in making this decision.