Why you should care about cash-based accounting and accrual-based accounting
How do you record a sale? When you share an invoice with your client, or when your client pays you? Your answer to this question will give you the fundamental difference between cash-based accounting and accrual-based accounting.
Cash-based accounting is relatively straightforward. You record business transactions that reflect on your financial statement as cash flows into or out of your business.
Alternatively, accrual accounting involves taking note of revenues or expenses when they occur, rather than when money is transacted.
Timing is everything, especially with tax liabilities. This is just one of the reasons you must be clear about what appears on your financial records, and when. As delving into tax may be too broad for now, you can book a consult with one of our professional tax advisors for more information.
Back to the topic at hand.
How do you choose the ideal accounting method for your business?
The following factors are key to helping you see which accounting method fits your business.
Stage of Growth
If your business is small and has yet to experience exponential growth, then I believe the cash-based accounting method is ideal.
As your business grows, you require a financial picture that extends beyond revenues or expenses. You need to understand your position on profitability. That is when the accrual-based accounting method will work well for you.
Simplicity
When you are tracking and managing your own business finances as a business owner, the cash-accounting method is simpler to understand and document. A cost-effective way to improve your financial tracking as your business grows is outsourcing a finance professional who is an expert in accrual accounting.
What are the noteworthy limitations?
As you seek investors to aid in your business expansion, the cash-based accounting method may make your business appear unprofitable, even when you have high-value clients in the works.
Cash flow is not trackable with the accrual method, thus, although your future may be highly profitable, a short-term cash crunch could indicate your business is facing challenges.
In a nutshell, both accounting methods are effective. The bigger your business becomes, the more complex your accounting system will be as well. Furthermore, when you begin to extend credit to your suppliers or clients, the accuracy of your financial health becomes clearer with accrual accounting.
Schedule a 15-minute call with a professional financial advisor and determine which accounting option is best for your business today, and in the future.
