Cash Accounting vs Accrual Accounting
Accrual accounting is the preferred method of recording transactions because it provides a more accurate representation of what actually happened during the period being reported. Cash accounting, on the other hand, records only those transactions that were completed during the reporting period.
Your accounting system will affect several things. For example, it will show different things to investors. It will also change when you owe taxes because of income or when you can claim expenses. Finally, it will affect your capacity to accurately budget and forecast.
What is Accrual Basis Accounting?
Because cash accounting doesn’t account for upcoming expenses and earnings, businesses often choose to use accrual accounting. Accounting on an accrual base means that revenues and expenses are recorded when they’re earned or incurred, instead of when they’re received or paid. Accrued income and expense figures are subtracted from each other to show profit or loss.
Accrual accounting enables investors to get a clearer picture of your company’s past performance and future prospects. Because income and expenses match up, investors can easily evaluate your business’s profitability. Accrual accounting provides a more accurate picture of your business’s performance. Income and expenses are matched together so that investors can see how profitable or unprofitable your business is. Accrual accounting shows investors exactly what your business earns and spends, allowing them to make informed decisions about whether to invest in your company.
Accrual accounting lets investors know exactly how much money your business made and spent last year. Accrual accounting helps investors understand your business’s profitability. You’ll be able to accurately predict your profits and losses. Accrual accounting allows you to forecast your finances and plan accordingly.
What is Cash Basis Accounting?
Cash accounting is definitely one of the easiest ways to keep track of your finances. By recording income and expenses when they happen, you can see exactly where your money comes from and goes.
There are no accrual or deferral issues with cash accounting, so your books balance out to match your actual cash flow.
However, if you’re not familiar with bookkeeping, it may take some time before you start seeing the benefits of cash accounting.
As with any choice you have in business, there are pros and cons to each option.
Some pros of cash accounting include:
- Know easily when to record transactions
- Easy to check for accounting errors
At the same time, there are several disadvantages to cash accounting. They include:
- Large payments appear in lump sums, making budgeting across time periods difficult
- Less likely to find investors
- Difficult to plan your budget
By the same token, there are many advantages to accrual accounting. They include:
- Smoother balances from time period to time period
- Attractive to investors
- Budget forecasting easier
Despite the advantages, there are also cons of accrual accounting. These include:
- Transaction recording somewhat more difficult as needs to coded correctly
- Just because you have cash in the bank does not mean it is free to spend – so look deeper
At MARKEF, we strongly encourage our clients to use accrual accounting. We believe it gives the fullest financial picture, allowing you to make responsible business decisions with your money. With your growing business, it’s the right move to make. Now the next question is who is the right partner to help as you grow up along this journey?
MARKEF offers a full suite of financial services for businesses including accounting services, VAT, and budget planning. Contact MARKEF today to get started with our financial services