Many small business owners prefer to pass on the expense of an accountant by keeping track of their billing and receiving themselves, and all will do so using cash or accrual methods of accounting, or maybe both.
In this article we will explain a little bit about cash vs. accrual accounting, including positive and negative sides of both.
Cash Accounting
Cash accounting is fairly straightforward and is by far the easier accounting method of the two to manage.
Cash businesses operate on a bill and payment only basis; a service or product is provided to the client, and then a bill is presented. Payment is not counted until the customer has actually paid for the invoice, at which point the money is transferred to the bank.
Usually, the cash method of accounting takes place on a month to month basis, showing a loss or a profit in terms of real money at the end of each period.
Accrual Accounting
With the accrual method in small business, however, cash is counted not when it is received, but when it is billed.
You still need to keep track of the cash when the invoices are paid, but you have already accounted for the cash in the month when you completed the contract (or when you sent out the invoice).
Words of Caution
Before we go on to analyze the attributes of both systems, it is important to warn you that small businesses (and large) which use a combination of both accounting systems are often destined for confusion in terms of their actual finances.
It’s not a recommended way of keeping track of things.
The Advantages of Both Systems
As we mentioned above, the cash system is much simpler to use than the accrual system, simply because it does not require as many steps before it is complete.
In addition, cash accounting will give you an idea of the real money that your business has to work with; you won’t need to operate on credit.
The accrual method, on the other hand, can give small business owners a much more accurate picture when it comes to the trends of their business.
You can tell from a simple glance at the books when your busy months were and when the slow months were because the positive dollar signs will indicate that it is so.
On the other hand, accrual accounting doesn’t rely on ensuring that all the money that your are owed has actually been collected; businesses using this method run the danger of running out of cash before all the bills are paid, but they are showing sales in the time they occurred.
The choice between the two methods of accounting is mostly up to you, with one exception.
If you run a small business which keeps a large inventory, you may be forced by the IRS to use the accrual method. In all other cases, it is a matter of whether you want a picture of your company’s performance or actual earnings.
