Small businesses need to understand the differences between cash-basis accounting and accrual-based accounting to determine which method will benefit them most.
Cash vs. Accrual Accounting: Which Is Better for Small Businesses?
Will you be using cash or accrual accounting at your business? That’s one of the first questions you’ll hear from accountants, because the answer is fundamental to how you will classify, record, and report on your income and expenses which can be different from what you need to manage your business.
When they’re first starting out most small businesses use cash-basis accounting for its simplicity, but before you make your choice, it’s important to understand how each method works and the benefits and downsides of each.
Features of cash accounting
With cash accounting, also called cash-basis accounting, your business records income only once you receive it. If you bill a client in February and they pay you in April, the income isn’t recorded until April.
The same principle applies to expenses—they’re only recorded when money leaves your business accounts to pay suppliers, vendors, and others. If you receive a bill from a vendor in October but don’t pay the bill until November, the expense is not recorded until November.
The big benefit of cash-basis accounting is its simplicity. It makes intuitive sense to most people because it’s similar to how personal finances are usually tracked, and it can be a good choice for small businesses that don’t have full-time accounting support.
On the other hand, cash-basis accounting can give you a distorted sense of your financial health. For example, you will know that you received a lot of income in a given month, but cash accounting won’t tell you when you actually earned the money—that might be important knowledge impacting your future staffing and other business decisions.
Features and benefits of accrual accounting
Under accrual-based accounting, businesses record income when they earn it, not when they receive it. Similarly, expenses are recorded when they’re billed instead of when the bill is paid. For example, if you bill a client $500 in June, that money is recorded as income for June, even though the client may not pay you until July.
Accrual accounting provides a more accurate financial picture than cash accounting because it shows your income and expenses as they happen. It is required for most organizations that follow generally accepted accounting principles (GAAP), and it is a good choice if your business is likely to grow because it’s scalable and provides a better long-term view of financial health.
Learn more
BST offers a broad portfolio of accounting and auditing, tax, consulting, and wealth management services to small businesses, including Virtual Accounting Solutions to assist with everything from managing daily accounting operations to collaborating on strategic planning and budgeting.
Contact us to learn more about how to select the right accounting method to reach your financial goals.
