Cash and accrual accounting differ quite a bit, and knowing just how they differ is important to every business owner whether you plan to hire a bookkeeping service Atlanta knows and trusts, or do your own accounting in-house. The main difference between cash vs. accrual accounting processes is in regards to timing; that is, when exactly your sales and expenditures are actually documented and listed in the business records. Each of these key accounting methods has specific characteristics and benefits as follows:
Accrual-based accounting involves expenses and revenues recorded as they are actually earned, no matter when the income is paid or received. The accrual method is preferred by many business owners due to its realistic portrayal of expenses and income in a specific time period. The accrual method is valuable for providing a long-term business assessment and picture. However, its downside is in that there isn’t much cash flow awareness. With accrual accounting, a business might seem profitable even if it actually has an empty or very low bank account. If accrual based accounting is chosen, then it will be important to monitor cash flow carefully going forward.
A great many small businesses choose cash accounting due to its straightforward quality and ease of use and maintenance. Cash based accounting acknowledges expenses only when paid and cash income when it is actually received. However, the cash method of accounting doesn’t recognize accounts payable or accounts receivable.
The cash method of accounting makes it easy for business owners to determine when transactions occur. It’s not necessary to track payables or receivables. Cash accounting is also helpful for understanding how a company’s income and expenses affect the bank account. Barring a few exceptions, a cash-basis company’s net profit/loss can be easily reconciled with the increase or decrease to the company’s bank balance. Since company transactions are not recorded until cash is paid or received, business income is not taxed until it is actually in the bank.
Accrual vs. Cash Accounting Business Effects
While an understanding of the nuances of both accrual and cash accounting is key to business savvy, these facts must also be put into context via examining the effects that each method has on a business from year to year. The cash and accrual accounting scenarios each affect a company’s bottom line in different ways.
For example, if a business has invoiced a client for $10,000 in work during a particular month, received a vendor bill for $2,000, paid $150 in miscellaneous fees billed by a vendor in a prior month and also received $2,000 from a client who had been billed the previous month, the effect on business cash flow status would be as follows:
Accrual accounting: Current monthly profit would be $8,000 ($10,000 in income minus $2,000 in fees).
Cash accounting: Monthly profit would be $1,850 ($2,000 in income less $150 in fees).
As this example illustrates, the “appearance” of a company’s cash flow and income stream is directly affected by the choice of accounting method that is used for that business in a given tax year.
Cash vs. Accrual Effect on Business Taxes
If the above business month example took place in the last quarter (November, October or December) of a standard year, the tax year affected would depend upon whether the accrual or cash accounting methods were used.
Each method affects which tax year both expenses and income are recorded. With the accrual basis, a client invoice of $10,000 in November would be recorded in the current year, and taxes would be paid on it even if the payment was received in January of the following year. Conversely, with cash accounting, income is recorded when it is received. With the accrual accounting method, income is recorded when earned (billed).
Both the accrual and cash methods of accounting have their strengths and weaknesses, and making the most of the type chosen requires an understanding of what specific numbers mean regarding your company’s financial needs and specific questions.
Ultimately, each accounting method only offers a portion of the complete picture of a business. Selecting the best method will probably be a changing and ongoing process as your company grows and evolves. Also, it should be noted that some business types are actually required to employ the accrual-based method of accounting. Contact a bookkeeping service Atlanta trusts to find out what’s required of your business.
If you’re still not sure about whether the cash or accrual accounting method is ideal for your company, consult with a professional bookkeeping firm in Atlanta, GA. They will help you to feel confident that you’ve made the very best decision for your business. Professional accounting in Atlanta can also provide continued strategic advice to support your business optimally as it grows, evolves and thrives.