With tax season behind us, it’s a good time to review how your business maintains its books. The two major methods of small business accounting (cash and accrual) each have specific advantages and disadvantages that could have a financial impact on your company.
Small Business Accounting 101
What is the Cash Method?
The cash method records income as it is received and expenses when they are paid. A payment is recorded when the cash is in hand and expenses are calculated after a transaction clears your bank account.
- Easier to use and maintain
- Tells you how much cash you have on hand at any given time
- You do not pay income tax until you actually receive payment
- Doesn’t provide an accurate long-term financial picture
- You can’t use this method if:
- Your company maintains inventory
- Your gross receipts total more than $5 million dollars in a year
- Your company is incorporated
What is the Accrual Method?
The accrual method uses the opposite approach to small business accounting. Income and expenses are not recorded when money changes hands. Instead, the transactions are recorded when they are billed and earned.
For example, your company might provide services in the first quarter of the year but will not get paid for them until the second quarter. If you use the accrual method, you would record the transaction in the first quarter of the year.
- Provides a more long-term view
- Accounts for money not yet received
- More recording and tracking
- Doesn’t offer an awareness of cash flow
Is one Method Better than the Other?
As you can see, each accounting method has its pros and cons. One is not necessarily better than the other. The choice depends on what is right for your company at the given moment.
Although either method is available to most business owners, accrual is much more commonly used.
If both methods appeal to you for different reasons, you could choose a hybrid approach. Some companies now use the accrual method for inventory and the cash method for income and expenses.
If you would like more information on cash vs. accrual or other small business accounting topics, consult a local tax accountant.