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Cash Basis vs Accrual Basis Accounting
Cash Basis vs Accrual Basis Accounting
When it comes to operating your own business, there are so many decisions you have to make, and each one will have an impact on the future of the business. You need to decide whether to hire a staff, what type of business entity would work best and how to manage the finances.
The financial management of your business is the backbone that holds everything together. Without a strong system for tracking income and expenditures in place, your business will face adversity. There are different methods to choose from, like the accrual method or the cash accounting method.
In the showdown of accrual vs cash accounting, you can see the ins and outs, and the pros and cons of each method.
Key Takeaways
- Cash basis accounting is best for small businesses and sole proprietors
- Accrual basis accounting allows businesses to easily manage their finances as revenue flows in
- Any incorporated business, except for an S Corp, is required to use the accrual method
Table of contents
What is cash basis accounting?
This accounting system keeps track of income and expenses only when there’s an exchange of cash. A business’ net income is accounted for only once they receive income or make a payment. Any pending transactions aren’t recorded.
This method is mostly used by sole proprietors and small businesses that deal in cash. It’s simple and easy to use, so very little time is spent learning how to use the system.
You might choose this accounting method if:
- Your customers pay in cash, money transfer or credit/debit card
- There are limited daily financial transactions
- You have only a few employees
- You use single-entry accounting
Advantages of cash basis accounting
There are some great advantages to using the cash basis method. If you own a small business, this accounting method might work best.
Tax advantage
Easy to use
Available cash
What is accrual accounting?
Accrual accounting consists of revenue matching and principal management. Revenue matching is when revenue and expenses are matched on an income statement and principal management relates to managing your funds put into loans or investments.
Accrual accounting reports any income, whether it’s been received in your account or not. The system recognizes income as soon as an invoice is generated.
Accrual accounting provides a thorough analysis of your finances. It includes accounts receivable and payable reports and balance sheets of liabilities, equities and stakeholders’ equity.
Advantages of accrual accounting
When it comes to business accounting, the accrual method is definitely the preferred choice since it allows businesses to manage their cash as it comes in. There are some important reasons why accrual accounting is the right choice for your business.
Managing performance
Accuracy
Planning for the future
Disadvantages: Accrual vs Cash
While every decision has pros and cons, there are stark differences between cash and accrual accounting methods.
Disadvantages of the cash basis method
Disadvantages of the accrual basis method
Cash vs accrual for small businesses
Any business that’s a corporation, except an S Corp, and had more than $25 million in total business from all sources over the past three years, is required to use the accrual based accounting method. If your business hasn’t met this limit, you can choose to use the cash accounting method.
Perhaps you aren’t happy with your accounting method and want to switch. In this case, you’ll need to file Form 3115 and get approval from the IRS.
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