Business owners have two options to choose from to track the income and expenses for their business, which includes cash vs. accrual accounting. It is essential to understand the differences between these two types of accounting to discover which option best suits your business.
The Accrual Accounting Method
With the accrual method of accounting, a business records income on the day it bills for services and not necessarily when it receives payment. For example, perhaps you billed a customer for goods on July 1, but the customer has until July 31 to pay the invoice. You would still record the payment on July 1 regardless of when you received it, or even if you received it on time. Any business can choose to use the accrual accounting method. However, the Internal Revenue Service (IRS) requires a company to use it once its gross receipts exceed 10 million dollars.
The benefit of this system is that it can give you a more accurate picture of your company earnings than the cash accounting method. Unfortunately, it can also make it appear that your company has more cash available than it actually does. If you decide to use the accrual accounting method and run into short-term cash flow issues, be sure to look closely at your company’s cash flow statement and cash flow forecast for a more realistic sense of how much it currently has available to invest or spend.
The Cash Accounting Method
Also known as the calendar year accounting method, using the cash accounting method means that you record payments as you receive them. In the above example of a July 1 invoice date and a July 31 due date, you would enter the payment into your company’s record of revenue on the actual date you received money from the customer.
Although this is the more straightforward method of bookkeeping, it can become complicated when you invoice for a product or service in one calendar year and don’t receive payment until the next calendar year. The same is true for paying expenses. If you opt for the cash accounting method, you can only claim income and expenses in the year in which you actually received funds or paid invoices.
This may not be a suitable method for your business if most of its sales occur in November and December. If you don’t receive payment until the next calendar year, your company could look cash-poor on paper. Additionally, the IRS imposes restrictions on the types of businesses that cannot use this method, regardless of annual revenue.
Feel Stumped When It Comes to Cash vs. Accrual Accounting?
At Capital Business Strategies, we understand it can be challenging to choose the most appropriate accounting method for your business. The good news is that we are here to help. Please contact us today to request a consultation to learn more about our consulting and other services to small business owners.