There are different types of accounting you can use in your business. The type of accounting you use can impact your financial reports that you use to run your business, and also your tax obligations.
In this episode of MissionBusinessPodcast.com, Bernard Roesch explains the differences between cash and accrual accounting, and how to know which is best for your business.
If you have any questions about this podcast episode, please feel free to contact us.
The Difference Between Cash and Accrual Accounting
The main difference between cash and accrual accounting is when you record your revenue and when you record your expenses.
- With accrual accounting, you record revenue when you invoice the customer. You may not have received payment yet, but that revenue is recorded in your books.
- With cash-based accounting, you don’t record revenue until you receive the actual payment. This means that you may have outstanding invoices, but those will not be counted as revenue until the payment is received.
When you record expenses is also affected by the type of accounting you use.
- With accrual accounting, you record the expense when you receive your bill, not when you pay the bill. This means that if you receive a bill that is not due for 30 or 60 days, that expense may still be recorded on your books when you receive the bill.
- With cash-based accounting, you record the expense when you send a payment for the bill.
The Benefits of Accrual Accounting
Accrual accounting helps you keep track of income and expenses as they’re earned and incurred, not received or paid. This can be helpful if you run a business that is a little more complicated or has revenue and expenses that are not paid quickly with cash. For example, if you delay paying rent, you still owe the rent to your landlord. Cash-based accounting would not show this as an expense since it has not been paid, but accrual-based accounting would.
The Benefits of Cash-based Accounting
Cash-based accounting keeps things simple.
- When money comes in you record that revenue, and when money goes out your record the expense.
- Some people get intimidated by accrual-based accounting and opt to use cash-based accounting instead.
- While this is understandable, due to cash-based accounting’s simplicity, it may not be best for your business.
Which Accounting Method Should You Use
You may use cash-based accounting to run your business and accrual-based accounting to file your taxes, or vice versa. Your tax preparer can make recommendations on which would be best for tax purposes, and you should decide which would be best for running your business.
There are certain situations where you may legally need to run your business with a certain method, but that’s something your tax preparer can help you understand as well.
For tax purposes, it can sometimes be helpful to use cash basis accounting.
- For example, if you invoice a customer but haven’t been paid yet, accrual-based accounting would show that revenue, which means you owe tax on income you haven’t yet received cash for.
- If you have lots of accounts receivable and accounts payable, or inventory, then accrual-based accounting is probably best so that you can keep track of these parts of your business effectively.
- If you get paid quickly and you pay vendors quickly, cash-based accounting is probably easiest to keep things simple.
The answer for which accounting method you should use depends on a wide range of factors.
You can also visit MissionBusinessPodcast.com for more insights that Bernard has been sharing with us in the previous episodes.