Keeping track of your money is a basic task that all small business owners have to undertake. There are two methods of accounting in common use: cash and accrual. Each has its pros (+) and also its cons (-).
Cash accounting is simple and straightforward. Recording the amount of cash coming in and leaving does not require any accounting or business knowledge.
Accrual accounting is not simple. It is complex and time-consuming, and it may require the assistance of a trained professional accountant.
Companies that use cash accounting always know exactly how much cash they have in their possession. Thus, they can track their cash flow and make informed decisions about daily operations that depend on cash flow.
Since accrual accounting does not take into account the actual amount of cash the company currently has in its possession, it may cause problems in companies that rely on regular exchanges of cash during their daily operation.
Accrual accounting provides a comprehensive overview of a company’s financial health because it records the actual time at which every financial event occurs. This approach supports good decision-making and long-term planning. It can help identify trends and assess the financial stability of the company.
Cash accounting does not provide a detailed or comprehensive overview of the business’s finances. Thus, it may hinder long-term planning and decision-making.
Accrual accounting relies on estimates and assumptions about future events. This approach can occasionally lead to incorrect or misleading results if the assumptions turn out to be untrue.
Cash accounting records when cash is coming in and leaving, rather than when services and goods are actually delivered and received. This can lead to incorrect or misleading results in financial reports.
Accrual accounting is preferred by banks, investors, creditors, the IRS, and regulatory authorities. These outside entities prefer it because it provides a transparent, detailed, and reliable record of the business’s finances.
These entities do not trust cash accounting, which can hinder a company’s ability to obtain funding and permits.
In general, only small businesses that rely on daily cash flows benefit from cash accounting. It is a good idea to talk to a professional accountant about which method is best for your company. Contact us today to discuss your company’s situation.