Every business owner needs an accounting method for recording and reporting their business’s income and expenses. In most cases, the choice often comes down to accrual vs. cash basis accounting.
Here’s a rundown on these top two accounting methods for small businesses.
Cash Basis Accounting
Let’s start with the simpler option. Cash basis accounting more immediately recognizes income when it’s received and expenses when they’re paid. It works almost like a personal checking account. Money comes in, you have it. Money goes out, you don’t. You always have a clear picture of your current business funds.
Accrual Accounting
Alternatively, the accrual accounting method revolves more around anticipated revenue and expenses. With this method, it doesn’t matter if you’ve actually received or paid any money — the transaction is still put on the books.
Here’s an accrual accounting example for both incoming and outcoming funds:
- Income. A business records a credit card payment after sending a customer an invoice, even though the payment hasn’t been received.
- Expenses. A business records the cost of hiring a consultant, even though the work hasn’t been completed.
The difference between the two essentially lies in timing. Cash basis is helpful in tracking how much money your business has at the moment — all you need to do is look at your bank balance and see the exact resources at your disposal. Meanwhile, accrual accounting provides a longer-term picture of your business, giving you a more realistic idea of income and expenses over the long haul.
Which Method Is Best for You?
Some businesses might be better suited to using one accounting method over the other.
Ideal candidates for cash basis:
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Sole proprietorships
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Companies without employees
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Small service companies
Ideal candidates for accrual:
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Businesses that make, buy or sell merchandise
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Companies that sell goods and services on credit
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Businesses that are expanding
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Businesses seeking investors or loans
- Businesses or corporations with annual sales above $5 million
Accrual vs. cash basis accounting is a major consideration that affects your business’s taxes and cash flow. The method you choose must accurately reflect your business’s comings and goings, and it’s something you report to the IRS. So don’t make your choice lightly!
For more tips on small business accounting, check out the National Funding blog.
