Cash Accounting vs The Accrual Method

If you own a business, you likely know how important accounting systems are for your financial records. How you approach accounting can impact your taxes, your financial reports, and even your profitability. There are generally two different approaches accountants use for businesses. One is cash basis accounting. The other is the accrual method. Both approaches have their own advantages and disadvantages. Deciding which is right for your business depends on your unique needs and goals. Each method could be right for some businesses and not right for others. Below is some information on each accounting approach so you can determine which is right for your business.

In cash accounting, revenue is recorded when it is received. Similarly, expenses are recorded when they are actually paid. Transactions are recorded based on the actual exchange of money. That may seem like common sense, but that's actually not how transactions are recorded in accrual accounting. One of the biggest benefits of cash accounting is that it's much simpler to implement than accrual accounting. According to the National Federation of Independent Business, businesses making less than $5 million may use cash accounting rather than the more complicated accrual method. That's an important benefit for smaller companies. It also offers a clearer view into cash management and allows businesses to better manage their cash on hand.

In accrual accounting, transactions are recorded when the sale is incurred, even if money is not exchanged at that time. This is common in businesses where services are invoiced at a later date or when sales are made on credit. Accrual accounting is more complicated than cash accounting but it's actually the more common of the two systems, especially among larger businesses. Accrual accounting is popular because it offers flexibility and potential tax savings. Businesses that use accrual accounting can take advantage of depreciation, which is not available for companies that use cash accounting.

The answer as to which type of accounting method is better isn't easy to answer. It depends on your business. If you're a smaller business that is transactional, cash may be better. That's especially true if you need to know your cash on a frequent basis. Accrual is better for larger companies, for those that want to take advantage of depreciation, and for those that make sales based on credit.

Talk to accountants in your area to better understand the two systems and determine which is right for you. An accountant can help you get the right system in place. Reach out to us today at Carpenter, Evert & Associates for more information.