Small business success weighs heavily on an accurate picture of profit and loss. Choosing to add a asset (such as a vehicle) or liability (such as taking out a business loan) is a critical financial decision that requires a full picture of the financial state of your business. The right accounting method for your business can help you make an informed decision.
Cash Accounting
Cash based accounting keeps track of income and expenses as they are added to the business. Since each bill or sale is recorded as it is paid, this eliminates the need for Accounts Receivable and Accounts Payable. Income taxes are also simplified as your company will only pay taxes based upon income received. The process of Cash accounting is simpler and works well for small businesses with limited amounts of inventory.
There are a few challenges that come with the cash accounting method. Each month’s income statement will not reflect accurately. For example, if you receive a bill in March for supplies used in February you will record the payment in March. This bill was an expense for February and should have been added to February’s income statement.
This method also presents a problem when a customer does not pay you in a timely manner. Your service or product has been consumed but you have not yet been compensated for it. There is not a pre-determined method for recording an anticipated payment.
Accrual Accounting
Accrual based accounting records income as it is earned and bills by the date issued. This method provides an up-to-date picture of the financial state of your business. Invoices and bills will be reflected within the financial statements of the month issued regardless of whether they were paid by the customer or business. This method is well suited for more complex and service-based businesses. Accrual accounting is endorsed by Generally Accepted Accounting Principles (GAAP) since it provides the most accurate financial picture.
Since the accrual method is focused on creating a long-term picture the short-term may be inaccurate. For example, a business may show a profit for February, but they have not yet received the funds from all the invoices sent out in that month. The bank account may be significantly lower in cash than what you would expect from the net profit. This method is also more detailed and complex requiring a more thorough knowledge of accounting principles.
Financial record keeping for a business will provide you with the tools you need to increase your profit and thrive. Whether you are looking for a simplified cash accounting method or a highly detailed, long-term picture from an accrual method, we would love to help you in your journey. Schedule a consultation call with us.
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