One of the most common questions that a business owner will have to answer is whether they should keep their books using the cash method or by following accrual accounting principles says Aron Govil. Accounting methods are separate from tax reporting – so if you need your business not to pay tax, you can follow either the cash or accrual method. If you want to pay tax, however, you must use the accrual method.
So why would we need to use the cash method of accounting and should I change from accrual?
Cash Method vs Accrual Accounting
The first thing that many business owners should understand is that there are two main ways in which business’ account for their income and expenses: Cash Method – Under this system, income is counted when it is actually received by the company (e.g., if a customer puts down a deposit) while expenses are recorded as they are paid (e.g., when an invoice arrives). This means that if no money has actually changed hands within the company, no credit or debit entry will be made in its books. The advantage to the cash method is that it will show the business as having more income and therefore less need to pay taxes.
However, since no money has actually been received for this income, you should take care in using the cash method – there’s a good chance that your company could get into trouble with its creditors or suppliers if they were not paid on time. Accrual- Under this system, both the income and expenses are counted when an actual exchange of goods or services occur (e.g., when a customer puts down a deposit) regardless of whether money has exchanged hands yet or not. The advantage to this system is that it can help businesses see where they stand financially at any given time; however, since we count revenue even before we receive payment, it can cause problems when it comes to paying creditors and taxes.
The cash method of accounting is the easiest for small businesses to use – since you are only counting money that has actually been received by the company at any given time; you have an easier time keeping track of your inflow of funds says Aron Govil. It also means that if there is no money coming in, you will not count any outgoing expenses. However, remember that if you do not pay your vendors on time using the cash method of accounting, they could refuse to sell more products or services to you since they have not yet been paid for their current sales to your business.
If one has a choice between using Cash Method vs Accrual Accounting, which should I choose?
The answer is, it depends on your business type.
Cash Method – If you are a retailer or distributor that does not offer credit to its customers. The cash method is best for you since all of your sales will be count when they are actually receive. This means less bookkeeping work for you and helps ensure that if there is no money coming in. You’re not force to count unnecessary expenses against your company. Accrual – If your business sells products or services with extended terms (i.e., net-30). Then it would generally be better to use accrual-based accounting. So that you can more accurately project how much money will come in each month. This figure becomes especially important when applying for bank loans where the lender will want. To see whether the company’s sales are increasing, decreasing or staying stable.
Cash Method vs Accrual Accounting – What is better for my business?
There are benefits to both cash method and accrual method of accounting; which you choose will depend on your business type. For businesses that deal exclusively with cash transactions, the cash method is probably best. Since it means less bookkeeping work for them after each financial period has ended. On the flip side, businesses that sell products or services on credit should chose accrual-based accounting. Because this system provides a more accurate picture of how much money they can expect. To make in future periods (helpful when applying for bank loans).
Cash is king when it comes to managing your business so if you can, only count the money. That actually lands in your bank account – you’ll be able to easily see how much cash you have. And won’t need to stress about collecting payments from customers explains Aron Govil. If your business does not offer credit nor has a history of bad debt. You’re probably better off choosing cash accounting. Because this will give you an easier picture of how much money you’re bringing in on a monthly basis.