Unit 5 - Cash vs Accruals Pt 1
In starting a business, choosing what type of accounting system you’re going to use is one of the necessary decisions you have to make. The two primary accounting systems utilized to keep track of revenue and expenses are cash accounting and accrual accounting, sometimes referred to as cash basis and accrual basis.
It is reasonable to be undecided yet which method you would like your business’ income and expenses to be monitored because selecting between the two is not easy. Therefore, to help you understand how these accounting methods work and to give you some ideas which one could best suit your business, read through the guide below.
Differences Between Cash and Accrual Accounting
Cash accounting system works by recording your business’ income and expenses only when they’re received and paid. For instance, if a customer sends you his payment on Monday for a particular product or service, you won’t record it until you receive his payment. If the money arrives on Wednesday, that’s just when you will record it in your books against Wednesday’s date.
Accrual accounting system lets you record all your income and expenses even though there’s no apparent collection and payment happening yet. For example, if a client orders some goods, you must record the total cost of the items even if you haven’t received his payment yet. Thus, it must be recorded in your accounts against the date the shipment of the products was made.
To compare the two accounting systems more closely, cash accounting takes down all the actual money received from the clients and spent for the business, while accrual accounting records the money you’re going to receive from your clients and spend for the business.
Advantages and Disadvantages of Cash and Accrual Accounting
Cash accounting is considered as a simple method to monitor how income and expenses flow in your business. This type of accounting system is usually recommended to smaller businesses that always deal with cash transactions. One of the businesses best suited to cash accounting is a grocery store because you can keep an eye on the money coming in and out of the cash register in this business. The only thing cash basis can’t do is to keep track of the money owed to you and the money you owe to others.
More complicated than cash basis, accrual accounting lets you record all your incoming and outgoing money although the activities haven’t occurred yet. This accounting method is perfect for large businesses, and even for professionals who invoice only after completing a project. Best examples of white-collar workers utilize accrual accounting include engineers and architects. Since they send an invoice only upon providing certain services, they have to choose accrual basis to record it as the amount of money owed to them.
Things to Think Over Before Choosing an Accounting System
The first thing you should ask yourself is how huge or small your business is. It is where you can determine if cash accounting is enough to handle all cash transactions. As aforementioned above, if you own smaller businesses like a hairdresser’s or a grocery store, it’s best you select cash accounting. However, if you happen to extend credit to clients and let them buy products and pay at a later time, that automatically means you have to choose accrual accounting since they owe you.