Everything You Need To Know About Cash And Accrual Accounting

Everything You Need To Know About Cash And Accrual Accounting post thumbnail image

No matter how big or small your business is, you should prioritise having a well-structured accounting system. It will help you with your business’s cash flow management and can be instrumental in achieving business goals. However, first, you have to decide on the type of accounting in your office. As a newcomer to the business world, you may find it challenging to make the final decision. This blog addresses the key differences between the two types of accounting and their pros and cons.

What is cash basis accounting?

Things you should know about cash basis accounting are as follows.

  • This type of accounting is largely used by small-scale businesses that constantly keep track of their cash flow. Because there is less to keep track of in the case of small-scale businesses, cash-basis accounting tends to be much easier.
  • In cash-basis accounting, all revenue is recognised whenever the business receives them. In addition, all expenses are also recorded when a specific amount of money is spent. It means, whenever you check your bank balance, cash-basis accounting will allow you to know what resources you have.
  • There is another benefit of this system: your revenue generally does not get taxed until the cash reaches your bank. However, there is an idea of ‘constructive receipt’ for specific amounts that become available upon demand.
  • However, the main drawback of this type of accounting is that it cannot give a clear picture of the financial status of your business. For example, your company may appear rich in cash while having considerable amounts of account payables because you haven’t paid them yet. In this situation, the financial health reflected in the bank accounts will look good, and potential investors may start thinking that your business will make a profit and continue to grow. But the truth is that your company will lose money after paying the accounts payable.

What is accrual basis accounting?

If you choose to have accrual accounting in your Perth-based business, you should consider the following factors.

  • In contrast to cash-basis accounting, revenue is recognised in accrual accounting when the company earns it. When a customer receives a product or a service that the business sells, the revenue is recorded. It is recorded before any change in the money takes place. On the other hand, various expenses are recorded after they are billed. To sum up, revenue and costs are recorded in this accounting system despite no involvement of cash.
  • A typical example is given here. Suppose another business or a person has to pay your company for receiving a service or product. When you send out an invoice to that customer, you should record that amount as your business revenue, even if you haven’t received the payment.
  • Unlike cash-basis accounting, accrual accounting is mainly used by large businesses and businesses with average yearly revenue of more than 26 million dollars. The reason behind it is that accrual accounting provides a clearer picture of the actual financial view of the business over a longer period and thus, benefits companies that have large inventories.
  • However, there are some disadvantages of accrual accounting, too. In contrast to cash-basis accounting, accrual accounting does not give the chance to track the cash flow actively. It can prove to be consequential for businesses that experience a cash shortage in the short term. When it happens, businesses have to spend money they do not actually hold in their accounts. The result may be zero cash in your bank. That is why experts recommend keeping someone for monitoring the outgoing costs and incoming revenue to be aware of the actual cash picture of the business.

Using cash-basis and accrual accounting in payroll processing

If you choose cash-basis accounting to process your payroll, the following things will happen.

  • The payroll taxes you have to pay will not be treated as costs that offset your revenue until you have cleared them.
  • It means the net income you include in your income tax return filing may get inflated in the short term.
  • Therefore, when you clear your payroll taxes, they will be treated as expenses, which will reduce your tax liability and reported profit.

On the other hand, when you choose to use accrual accounting for your payroll, you must face the following situations.

  • Payroll taxes will be recorded as costs when accrued, no matter when you clear your employees’ payments.
  • Thus, the net income recorded as your business income reflects that payroll taxes must be paid even if they are not due.
  • This way, an accrual accounting method helps a business owner keep track of the amount of money they owe.

What factors should you consider when choosing your accounting method?

As a business owner, it will be you who should decide on the proper accounting method. To figure out which method will best suit your business, you have to consider the following factors.

Doing a business involves lots of effort and hard work. As an owner, you will need to look after a lot of things, which can be stressful at times. Bookkeeping is a job that is highly time-consuming too. Many small business owners choose to do the job themselves initially but soon start experiencing the stress when piles of work require to be finished in a short time.

When you hand over the financial duty to your trusted outsourced bookkeeper, they can do the tasks of filling payment receipts and sending out invoices. In a word, hiring a bookkeeper will reduce your workload. It will give you more time to focus on other matters necessary for your business growth.

Any business venture cannot be successful without proper teamwork, and for all the team members, a sufficient balance between work and life is necessary. So, when you start your business, consider hiring a bookkeeper for your business.

If an error occurs in bookkeeping, you will need to redo the whole process, consuming a considerable amount of time. Remember that even a minor mistake in tracking the finances can prove to be costly for your business. At the time of taxation, if the Australian Taxation Office (ATO) finds issues like recording or reporting incorrect information, they can impose hefty fines on you.

On the other hand, when you outsource your bookkeeping service, the chances of
making mistakes are less. You can be sure that all the transactions are getting accurately recorded and will be reported correctly to the government agencies.

Size of the business

The most important parameter you have to take into consideration is how large or small your business is. A small business involves fewer transactions than a large company and thus will need cash-basis accounting for its simplicity.

The complexity of the business transactions

Another factor you have to keep in mind is how complex your business processes and transactions are. In large companies, various sources of revenue and expenses are involved, and thus a complicated business structure is expected. In that case, accrual accounting will be the appropriate one.

Having resources to manage accrual accounting

An accrual accounting is a complex method and thus requires specific resources for management. For help, you may get in touch with professional accounting services.

Final words

One thing to note here is that both these methods have their benefits and drawbacks. You have to choose the appropriate system based on your business requirements. Business firms offering top-quality cash management services will be the best place to go for assistance.

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