Accrual vs. Cash Accounting: Which Is Right for Your Business?
One of the biggest surprises entrepreneurs find when balancing the books is that there’s more than one way to do so.
Accounting is done via not one but a few methods, and one way may very well be a better way than the others depending on your business. Your accounting method will impact your financial reporting, tax obligations and overall decision-making.
Today, we’ll explain the two primary methods – accrual accounting and cash accounting – as well as the advantages and drawbacks of each. Understanding the differences can help you determine which is best suited to your business needs.
What Is Cash Accounting?
Cash accounting is a straightforward accounting method in which transactions are recorded when money changes hands. Revenue is recognized when payments are received, and expenses are recorded when they are paid.
Pretty simple.
The Pros
- Simplicity: This is an easy accounting method to understand and execute.
- Improved cash flow awareness: Because transactions are recorded only when cash moves, it provides a clear view of available funds.
- Tax advantages for some businesses: The cash accounting method gives you a great deal of control over when income and expenses are recorded. Thus, a business can pull either into the current year, or push either into the next year, in ways that may benefit them come tax time.
The Cons
- Limited financial insight: Does not account for accounts payable or receivable, potentially distorting the picture of financial health.
- Larger businesses may not use it: The IRS requires businesses with more than $27 million in average annual gross receipts over the past three years to use accrual accounting.
What Is Accrual Accounting?
Accrual accounting records revenue when it is earned and expenses when they are incurred, regardless of when cash is exchanged. This method provides a more accurate picture of a company’s financial health by including accounts receivable and accounts payable.
The Pros
- More accurate financial reporting: Captures a complete picture of business income and expenses.
- Easier to secure loans or investments: Lenders and investors prefer financial statements prepared using accrual accounting.
- Better long-term planning: Helps businesses track profitability and trends over time.
The Cons
- More complex: Requires tracking accounts payable and receivable.
- May create cash flow challenges: Revenue is recorded before the cash is received, which can create a disconnect between reported profits and the funds a company actually has available.
- Tax implications: Your business might owe taxes on income you haven’t yet collected.
Accrual vs. Cash Accounting: Which Method Is Best for Your Business?
The choice between cash and accrual accounting depends on several factors.
For one, the size of your business matters. Smaller businesses and sole proprietors often benefit from the simplicity of cash accounting. Larger businesses not only can benefit from accrual accounting — depending on their size, they might not have a choice.
Another significant factor is whether your business heavily relies on cash or credit payments for transactions. If you use a lot of cash, the cash-based accounting method is likely better for you. But if you use a lot of credit, the accrual method might be best.
Also, some industries might prefer one method over the other based on business cycles and payment structures.
Still Not Sure How You Should Run Your Accounting?
Choosing the right accounting method isn’t just about compliance – it’s about making informed financial decisions that support your business’s growth.
McManamon & Co. provides a wide variety of accounting services, where we can either do the work creating financial statements, maintaining records and performing other accounting tasks, or provide expert guidance on financial accounting matters, including which accounting method would be most beneficial to you.
Want to know more about how we can help you with your accounting needs? Call McManamon at 440.892.8900 or contact us online today.
Tags: accounting, accounting services, accrual accounting, cash accounting, McManamon | Posted in accounting, McManamon & Co.