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Cash vs. Accrual: Tips on Choosing the Best Method of Accounting for Your Small Business  

Cash vs. Accrual: Tips on Choosing the Best Method of Accounting for Your Small Business  

When you were a kid, you knew you wanted to become a business owner someday. Recently, you turned your entrepreneurial dreams into a reality. While you enjoy being your own boss, you desperately desire the answers to many burning questions. For instance, you want to know if you should choose the cash method or accrual method of accounting for your small business. If you can relate to this scenario, consider the following advantages and disadvantages of these two generally accepted accounting methods.

Cash Method

The cash method of accounting requires you to record transactions when money switches hands. You recognize revenue when you receive cash for a sales transaction. You record expenses when you pay for them. For instance, suppose you invoice a client for $500 on February 1. However, you don’t receive the client’s payment until March 12. You would record the revenue transaction in March’s bookkeeping.

Advantages of the Cash Method

  • Simple to Understand - Perhaps the greatest advantage of the cash method is its simplicity. This popular method of accounting only requires you implement a single-entry system.
  • Delayed Income Tax Payments - With the cash method, you don’t pay income tax on any revenue until you actually receive payment. Imagine you complete a large project for a client in 2017. If you don’t get paid for the project until 2018, the transaction will be excluded from your 2017 taxable earnings.
  • Depicts Cash Flow - The cash method accurately depicts the amount of cash you have on hand at any given time. It most looks like an actual cash flow statement.

Disadvantages of the Cash Method

  • Inaccurate Long-Term Indicator - While the cash method resembles a cash flow statement, it can be an inaccurate long-term indicator of profitability. The cash method fails to show revenue invoiced, but not received. It also doesn’t provide a small business owner with any information regarding future expenses. You might feel February was an overwhelmingly profitable month. Upon closer examination, you may realize this smallest month of the year was actually a slow one for your business. You might have simply collected an uncommonly high amount of cash from customers for merchandise sold in previous months.
  • Restrictions - The IRS forbids certain types of companies from utilizing the cash method. You can’t use this generally accepted method of accounting if:
  • Your company maintains inventory.
  • Your business’s gross receipts exceed $5 million dollars each year.
  • Your company is incorporated.

 Accrual Method

The accrual method of accounting requires you to record revenue when it’s earned and expenses when they’re incurred. For example, imagine you provide services to a client on May 4, but the client doesn’t pay you for these services until June 8. You would record the revenue transaction in May’s bookkeeping.

Advantages of the Accrual Method

  • Matches Revenue with Expenses - When compared to the cash method, the accrual method better matches revenue with expenses during a period of time such as a month or a year. The accrual method is a particularly superior gauge of profitability if your company extends credit to its customers. It’s also beneficial if you often complete services for clients in one period but invoice them in the next one.
  • Delayed Income Tax Payments - Like the cash method, the accrual method can result in delayed income tax payments. For instance, suppose you receive an advance payment in 2017 for a project you’ll complete in 2018. This cash receipt won’t be included income until 2018. 

Disadvantages of the Accrual Method

  • More Complex Than Cash Method - Due to the double recording of some revenue and expense transactions, many small business owners view the accrual method as more complex than the cash method. The extra paperwork involved with the accrual method may also make it more expensive to implement.
  • Disregards Cash Flow - Accrual accounting disregards cash flow. Your income statement might show tens of thousands of dollars of revenue. If clients haven’t paid their invoices, the cash received for the period might be significantly less.

Because the cash and accrual methods of accounting both have pros and cons, you might be struggling to select the right one for your small business. If you’re unsure of how to act, seeking guidance from a professional accountant is a smart idea.

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Frank Jenkins Jr

Frank Jenkins Jr

Frank Jenkins Jr. is the managing partner of Adams, Jenkins & Cheatham, a CPA practice based in Midlothian, VA. Frank specializes in Consulting services, tax planning, accounting, audit & assurances. "I genuinely care about our clients because I have a personal connection with them. This job requires me to multi-task and work under tight deadlines. I get great professional satisfaction from balancing firm and client commitments while building a strong team here at AJC."

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