Cash or Accrual Accounting Method: Which is right for you?
If you’re a CFO or business owner, you’ll likely need to decide between the cash or accrual accounting method for your business. Each has multiple advantages and disadvantages, depending on the size of your business and the industry you operate in. Before choosing the cash or accrual accounting method for your business, it helps to understand each one and its possible implications for your company.
For instance, each recognizes revenue and affects your taxes differently. Each method is a different way to record financial transactions for your business. The complexities and intricacies of both methods will affect a business differently. Here’s what you need to know before choosing the cash or accrual accounting method for your business transactions.
Differences Between the Methods
When choosing between the cash or accrual accounting method for your business, you must first understand how each method paints a different picture of the company’s cash flow. To do that, you must understand the differences between the two methods.
The accrual method of accounting is required for larger businesses with gross revenue of over $25 million annually because their financial transactions are more complex. Smaller businesses can choose between the cash or accrual accounting method.
The cash method of accounting provides a snapshot of the business’s current revenue streams while the accrual method offers a more accurate picture of a company’s financial obligations and incoming revenue. The cash method recognizes revenue and expenses when paid out, while the accrual method recognizes them when they are incurred. Recognizing the differences between the cash or accrual accounting method can help keep your business compliant as you record financial transactions.
Examples of Cash or Accrual Accounting Methods
Let’s look at an example to illustrate the differences between a small remodeling company’s cash and accrual accounting methods. The company sent a customer an invoice for $20,000 for a small addition completed that month. The company also received invoices totaling $5,000 from contractors who helped complete the job. The remodeling company also paid out $500 in bills that were received the prior month and a $5,000 payment from another client who was invoiced the prior month.
Cash Method – Monthly profit was $4,500 ($5,000 payment received – $500 in bills paid)
Accrual Method – Monthly profit was $15,000 ($20,000 invoice sent – $5,000 invoice received)
Each method paints a very different financial picture of the same company. While the cash method is simpler, the accrual method is more accurate. Consider this when choosing between your business’s cash or accrual accounting method.
It is also important to note that it can be difficult to change once an accounting method is chosen. While possible, changing the method requires several steps, including filing the proper paperwork with the Internal Revenue Service and changing the books.
Choosing the Cash or Accrual Accounting Method
Choosing the cash or accrual accounting method is important for your business. While changes can be made, it isn’t easy or always practical. Sometimes, it helps to speak with a client accounting services team to determine which method is right for your business. Be sure to consider the tax implications, the size of your business, and the industry you operate in before deciding. Once your research is done, you can choose between the cash or accrual accounting method for your business.
