Cash basis vs accrual basis accounting
There are different types of accounting for small businesses, and as with everything else, each has pros and cons.
Cash basis accounting records revenue when cash has been received, and records expenses when cash has been paid out. This is a simplified accounting method used most often by individuals and small businesses that do not maintain inventory since it is the simplest accounting.
Advantages of cash basis accounting include:
Taxation. Commonly used to record financial results to tax purposed, certain payments can be hastened in order to reduce taxable profits, which defers the business’ tax liability.
Ease. Cash basis accounting doesn’t require extensive knowledge for recordkeeping and simple software solutions can be used.
Disadvantages of cash basis accounting include:
Accuracy. With this type of accounting, businesses can alter results with the timing of cashing checks or altering payment timing.
Lending. Since there isn’t as much accuracy, financial statements cannot be relied upon as heavily when reviewing a company for small business loans and lines of credit.
Reporting. Results of cash basis financial statements lacking accuracy cannot be used in good faith to issue management reports for decision-making purposes.
Past the initial startup phase, most businesses should look to a more advanced and accurate accounting method, like accrual basis accounting.
Accrual basis is a method of recording accounting transactions for revenue when earned and expenses when incurred. It requires the use of allowances for sales returns, bad debts, and obsolete inventory, all of which are in advance of actual occurrence. It’s important to keep in mind that auditors will only certify financial statements if they were prepared using the accrual basis method.
Matching revenue with related invoices is the key advantage of accrual basis accounting, which means the complete impact of a business transaction can be seen within a single reporting period.
Which method of accounting to use varies based on stage of business, complexity of needs, and whether or not growth is a goal.