There are two ways to set-up your accounting – cash or accrual based. There are advantages and disadvantages to both methods. Before choosing one to use, do your research and work with a professional to determine the method that may be best for your business. The main difference between the two is the timing.
Cash basis accounting records transactions as money is exchanged. When a payment is received, it should be logged. When a payment is made, it should be logged. Cash basis accounting simply follows the ins and outs of cash. Because of this, cash basis accounting does not log accounts receivables or accounts payable because sales made with credit are not accounted for until the cash is exchanged. For cash basis accounting, you do not pay taxes on money that has not been received yet (even if it has been billed). However, accrual basis accounting requires you to pay taxes on money that you may still be owed, which is just one reason why it’s so important to stay on top of your bookkeeping.
Accrual basis accounting records transactions as they happen, whether money is exchanged or not. This means accounts receivables and accounts payable are logged, which allows for a more realistic and accurate representation of where your business stands. On the flip side, cash basis accounting shows a distorted view, making it harder to forecast and plan using this method.
The accrual method is more widely used, as it fits most businesses. However, cash basis accounting is a good fit for those starting a new business or own a smaller business. It’s simple and accounts for all cash paid or received, which is usually more than enough for new businesses. As you grow and adapt, switching over to accrual will allow you to be more complex and specific with your tracking, allowing you to log credits, which will be smoothed out as money is exchanged.
A downfall to the accrual method is that it does not track cash flow. This can create some issues if your company is having issues with cash and need to stay on top of the ins and outs. On the other hand, cash basis accounting may make a company look like they have extra cash, since it strictly follows the movement of cash, and it may not be an actual representation of your current cash flow.
Before choosing a method and diving in, make sure it’s the right one for your business and its financial needs. Again, if you’re unsure what to do, please reach out to a professional for assistance.