If you are starting a new business and want to select either Cash basis accounting or Accrual basis accounting, then it might be difficult and confusing for you to select one of them. Both Cash basis accounting and Accrual basis accounting have their own benefits which will bring success to your company. You have to choose one of the methods depending on the needs and requirements of your business or company. The most important difference between these two methods of accounting is the timing of when your company accounts for its expenses and revenue earned by the company.
Today in this article we will give you a complete overview of both cash basis and accrual basis accounting. This will help you to maintain good business health. So, read the article till the end. And make a clear vision to choose the best accounting method according to the needs and requirements of your business in a proper way.
What is Cash Basis Accounting
The method to track and record the cash transaction of your company is known as Cash Basis Accounting. In other words, cash basis accounting keeps a track of the cash coming into your company’s account and also keeps a track of the cash going out of your company’s account. Thus it will help you to get a complete overview of the remaining cash in your account at the end of the month.
In Cash basic accounting you don’t have to follow the rules and regulations of Generally Accepted Accounting Principles. This accounting method consists of only two steps. One step is to record the revenue when your company receives actual cash from your company’s customers. The other step is to record the expenses when you pay the employees and vendors of your company. It is the simplest form of accounting, but this method of accounting will not give a complete overview of your company’s performance. Cash Basis Accounting is mostly used by businesses that do not have inventory and by sole proprietors.
Advantages of Cash Basis Accounting
Now let us have a look at the advantages of using Cash basis accounting:
- It is the simplest method of accounting which gives you a clear picture of the remaining cash in your account at the end of the month.
- This method of accounting doesn’t need any experienced accountant.
- In this method of accounting the business owners only have to pay taxes on the money they received. They don’t have to pay any taxes on the invoices that they have issued.
Disadvantages of Cash Basis Accounting
There are some basic accounting principles to manage finance if we will go against the principles then we may get disadvantages of the plans. So always try to follow all the principles, and now let us have a look at the disadvantages of using Cash basis accounting:
- Cash basis accounting is not an accurate method of accounting.
- Cash basis accounting will not give a complete overview of the performance of your company.
- This method of accounting will only give you the overview of the finances of your company.
- You will not be able to make any management decisions for your company on the basis of Cash basis accounting.
What is Accrual Basis Accounting
Unlike Cash basis accounting, Accrual basis accounting is a bit critical method of accounting. Accrual basis accounting uses a matching principle to record the transactions of the company. In other words, in this process of accounting, the business owners have to match the revenue earned by the company with the expenses of the company in a particular time period.
Accrual basis accounting will give a complete overview of the performance of your company. In accrual basis accounting, all the entries occur before closing the finances of the company for a month by the business owners. Thus it will help you to identify the revenue in the correct period of time and accruals for any expenses which are not paid yet in that particular period of time are also accounted in accrual basis accounting. So we can say that Accrual basis accounting is more complicated than cash basis accounting. On the other hand accrual basis accounting will give a complete overview of the performance of your company rather than fluctuations that occur with cash basis accounting and rather than tracking only the cash flow that occurs in your company or business.
Advantages of Accrual Basis Accounting
Now let us have a look at the advantages of using Accrual basis accounting:
- Accrual basis accounting will give a complete overview of the performance of your company.
- When you use Accrual basis accounting for your company, you will be able to make any management decisions for your company on the basis of Accrual basis accounting.
- In this method of accounting, you will be able to pitch for long-term finance for your company.
Disadvantages of Accrual Basis Accounting
Now let us have a look at the disadvantages of using Accrual basis accounting:
- Accrual basis accounting is a more complicated method of accounting than Cash basis accounting.
- In Accrual basis accounting, it does not track the cash flow in your company’s account but keeps a track of the invoices.
- In Accrual basis accounting the business owners have to pay tax on income before the customer has actually paid the business owners.
- In Accrual basis accounting,it does not track the cash flow carefully which can cause a devastating impact on your business or company.
Which Accounting Method is Best for Your Business?
The decision of whether to use Cash basis accounting or Accrual basis accounting for your business completely depends on the needs and requirements of the business. To choose a type of accounting method, you have to keep a lot of factors in mind. You have to make an effective plan whether to use Cash basis accounting or Accrual basis accounting for your business before you file your choice to the IRS.
If your company does not want to focus mainly on the accounting process, then cash basis accounting is ideal for your company because this method of accounting is very much easy and simple. Thus you and your employees can mainly focus on other strategic plans for the wellbeing of your company. Cash basis accounting is most commonly used by startup businesses as it is the easiest way of accounting and it does not require any experienced accountant. In the case of reporting, cash basis accounting might show large fluctuation because your company might earn a lot of profit in one month but in the next month, your company might not earn so much profit because of the timings of money and receipt going out. Thus this method of accounting will not give you the picture of overall profit or loss earned by your company.
If your company wants the books to be audited, if your company wants to consider selling the company soon, if your company wants to obtain bank financing, if you want your company to go public, then you must choose Accrual basis accounting for your company. If you want to show the performance of your company to any external parties and investors, then you have to choose Accrual basis accounting because the external parties and the investor always want to know about the overall performance of the company. The Accrual basis accounting also allows for Generally Accepted Accounting Principles compliance. In the case of reporting, Accrual basis accounting will give you a complete view of your company’s profitability. In Accrual basis accounting you will be able to recognize revenue and expenditures in the period in which the revenue was earned and the expenses occurred.
Thus you have to know the needs and requirements of your business to choose the best accounting type for your business.
We hope that now you completely know about Cash Basis and Accrual Basis Accounting and would be able to choose the best accounting type for your business easily by yourself. Just follow all the points carefully, the guidance provided in this article will definitely help you to choose the most effective accounting type for your business in a hassle-free method. Wizxpert recommends you read the entire article and follow all the points without skipping a single point.