Cash Basis Accounting & Accrual Accounting - Our Guide
No matter what type of business you own, having the right accounting method is crucial. Choosing the right method is essential when filing your tax return because you will use this method on all your subsequent returns. The two primary methods are cash basis accounting and accrual accounting. As a business owner, you cannot just choose one at random.
You need to know the differences between the two methods and what effects they can have on your business. Here’s more information on cash basis accounting and accrual accounting:
Cash basis accounting
In cash basis accounting, revenues are recorded only when cash is received, and expenses are already paid. If a transaction hasn’t been completed yet, the revenue will not be recorded. That said, you must also keep in mind that accounts receivable or payable are not recognized by cash basis accounting.
Most of the time, this accounting method is used by small businesses and those who manage their personal finances. This is because it is very simple and easy to maintain. Since you don’t have to track receivables or payables, everything is laid out for you. You will only have to be concerned about whether your money goes in or out of the bank.
Whenever there is a transaction, it is not complicated to manage at all. Another reason why this method is so popular is that it allows business owners to check the cash balance that they have in real time. When you use cash basis accounting, you will be able to see exactly how much cash you have in the bank. Because there are no records of incomplete transactions, your income will not be taxed until those transactions go through.
While cash basis accounting only recognizes when cash is paid or received, accrual basis accounting is the complete opposite. Whenever you make any transactions, they will instantly be recorded as your revenues and expenses. You will see changes in your records whether the money is already in the bank or not. Although you may feel like it is more complex than cash basis accounting, accrual accounting is actually more widely used than the former.
The major advantage of this accounting method is its ability to give you realistic data over a particular period of time. Instead of having to wait for everything to be completed, you can see the anticipated balance and plan from there.
Accrual accounting provides you with an overall picture of your company’s balance over a long-term period. Cash basis accounting lacks this ability. However, this method isn’t without its disadvantages. The amount of money that you see is not really in your bank accounts. You may think that your business is generating a lot of profit when, in reality, there is no cash in the bank balance. If you don’t monitor your cash flow carefully, there can be terrible consequences for you and your business.
Both cash basis accounting and accrual accounting have their perks and pitfalls. It is essential to pick the right method to use. Do not choose a method just because it is what everyone else is using. You should pick the accounting process that is most suitable for your business.
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