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Cash or Accrual Accounting? Understanding The Difference

Friday, April 24, 2015   By Mike Reddy

 

Cash Or Accrual Accounting

In the days before accounting programs that easily accommodate both versions, you used to have to choose between the two. Now that’s no longer necessary but it still pays to know the difference between the two.

It’s all about timing. How you are recording and when you are getting paid.

Cash-based accounting means what it says, nothing is recorded until cash actually exchanges hands. When pay outs are made and when invoices are paid, you hit the books and record the transactions. What are the pros?

PROS:

  • This truly is the simplest way to balance the books - nothing is credit based or fictional, and looking at your numbers will always reflect a real-time picture of financial standings.

  • It is mostly suited to small business in which cash must be tendered in the actual rendering of services, i.e. grocery stores. You cannot leave the store with your items, unless the items have been paid for.

Accrual based accounting requires a more meticulously devised system. When using this system, you record sales and payments when the deal is made. While more complicated, this system also shows you a more long-term cross-section. What are the pros?

PROS:

  • More complicated does not necessarily mean bad - this system is more in-depth and better suited to long term planning and growth.

  • It gives you a better understanding of the profitability of your business. You can’t make things “look” better just by not paying a bill!

  • This method is also better suited towards large transactions and multiple contracts.

  • Best for businesses who commit to completion - architects and contractors who may consider the sale “money in the bank” though they will not be paid until completion.

When determining which system best suits your business, consider three things:

  1. 1.  Scope and size of prospected business.
  2. 2.  Are your transactions swift and simple, or drawn out, generally larger and more complicated?
  3. 3.  Do you have/can you afford the resources to manage a more demanding system (i.e. bookkeeper)?

CON’s of Cash? This system creates difficulty when tracking and planning - creating challenges in matching revenue to money-earned.

CON’s of Accrual? This system makes it more challenging to track actual cash flow. Although accounting software can now take a lot of these problems away.

Most widely recommended for small businesses is cash-based accounting and you can justify the switch once business begins to take shape.

Of course, the best thing to make sure you use the best system for your business is to chat with us!


Mike Reddy is a Chartered Accountant, business coach and advisor helping businesses in Sydney, Melbourne, Brisbane and Gold Coast to easily increase their profits and cash flow. He is currently President of the North Sydney Chamber of Commerce, a Regional Councillor for Sydney North East and a member of the Institute of Chartered Accountants Sydney leadership team. As well as advising businesses, Mike presents business development seminars and webinars and is regularly contacted by the media to comment on small business matters. You can connect with him on Facebook, Twitter and Google+.