Which method of accounting do you use?

As a small business owner, you should understand the difference between cash and accrual accounting. If you don’t, your company’s financial health could suffer.

That’s why we’ve outlined the two methods below by explaining how its methods could affect you.

Defining Cash Accounting

Cash accounting is defined as just that; accounting for revenue and expenses only when cash is actually received or paid. Meaning, owners are not accounting for anything that has yet to happen, regardless if it is scheduled or assumed to be happening in the near future.

The main benefit of cash accounting is the similarity it offers. It is an easy to understand method of assessing a company’s financial health that provides an accurate picture of real-time transitions. This prevents owners from operating under assumptions when it comes to things like taxes, benefits, or claims.

However, cash accounting can give owners limited insight into a company’s financial health since it does not account for any outstanding receivables or payables.

Defining Accrual Accounting

Unlike cash accounting, accrual accounting notes revenue and expenses when they occur, regardless of whether or not cash has exchanged hands. Meaning, every time a client is invoiced, that amount will be counted as revenue even if it hasn’t yet been paid.

The benefit of this type of accounting is that it gives a more accurate picture of where a company’s financial health is at by including any future income or expenses. This comprehensive picture is better for long-term planning since it will help with forecasting and budgeting.

Despite the long-term insights that this method provides, the downside is that it can be rather complex. Therefore, it might require a deeper understanding of accounting principles in order to prevent inaccurate recording which could lead to cash flow challenges.

What is Right for You?

There are typically three main factors that influence the type of accounting used for a business. These include: the business size, the nature of its transactions and the financial goals of it.

The size impacts the type of accounting used given that smaller businesses likely have fewer transactions and expenses to account for. This means that cash accounting might be the way to go given its simplicity and accuracy, whereas larger companies might benefit from the more detailed insights that accrual accounting can provide given the larger number of transactions to account for.

The financial goals of a business also impact the type of accounting that should be used, seeing as accrual accounting tends to be better for projecting long-term growth. Whereas, more immediate financial planning (like tax preparation) is better with cash accounting given its real-time summary.

Why Not Both?

Both accounting methods provide great benefits which are why implementing both is something that might want to be explored. Cash accounting is ideal for real-time updates and tax planning; in turn, helping owners understand exactly where they stand. However, accrual accounting is better for long-term strategizing.

If you choose to use both, we suggest visiting a financial professional, like us at A.P. Accounting & Tax Services. A professional will be able to make the necessary adjustments to your financial records by reconciling all accounts to ensure consistency in every report.

Otherwise, without the help of a professional, you could be misinterpreting your financial health, leaving you at greater risk of unexpected expenses and a limited cash flow.

So, if you’re an owner wondering how accounting could impact you, consider getting some professional help by speaking with us at 407-328-5001.

Image: Unsplash