When it comes to managing your business’ books, one of the most important decisions to make is choosing which accounting method to use. Thankfully, there are only two options: accrual accounting and cash-basis accounting. While cash accounting recognizes expenses and revenues only when money changes hands, accrual accounting recognizes expenses when they’re billed and revenue when it’s earned.
What’s the cash method?
In this method, you record income when you actually receive payments and you have cash at hand. On the same note, you record expenses when you write a check and the money actually leaves your account. This is basically how people manage their financials and balance their checkbooks. It’s a simple method of accounting that usually makes a lot of sense. However, this method might eventually interfere with your expenses and income.
Basically, it doesn’t account for all the situations where you’ve used credit to buy supplies or given your customers goods on credit. It can, therefore, make you believe that you are having a very high cash flow when it’s actually just a result of last month’s work.
What’s accrual method?
With accrual method, expenses and income are usually recorded when they are supposed to be paid. This means if you make some sale, it’s supposed to be recorded as income on the date of sale and not when it’s actually paid. Expenses are also recorded on the day it’s incurred even if you don’t pay for it. According to experts, the accrual method will give you a better picture of the financial situation of your business since it takes care of the money that flows in and out of your business.
The only disadvantage of this method is that it doesn’t account for funds or cash flow that are already in your bank. If you are not careful, this method of accounting could eventually be financially devastating for the small business owner since it could represent a huge amount of income when your bank is actually zero.
Which method is better?
When we compare these two methods, then the cash method is a more direct way of accounting. On the other hand, the accrual method requires a lot more bookkeeping. While the accrual method accounts for the money that’s yet to come, the cash method will give you a picture of the funds in your bank account.
As a small business owner, you are free to choose the method you want, but if you must keep an inventory, then it’s advisable to use the accrual method.
Your Valuable Partners for Small Business Accounting
For more information on the best method, contact us at Norton Financials. As valuable partners, we will implement the necessary systems and processes to run the financials of your business as smooth as possible.