By Analytix Editorial Team
Both, cash and accrual methods are used for recording accounting transactions.
With the cash method, there is no record of accounts payable or accounts receivable. Instead, revenue is recorded when cash is received and expense is recorded when cash is paid out.
The cash method also serves as an indication of whether there is any money in the business’s bank account or not. Small businesses may choose to use this method for the ease of tracking money, and there are fewer hassles such as those involved in pursuing invoices or overdue payments.
Advantages and Disadvantages of the Cash method:
A distinct advantage of the cash method is that the business knows exactly how much cash it actually holds. Moreover, unless cash actually changes hands or exits and enters the business, income is not taxed.
But this method may not stand intense growth phases or periods where the business may not get paid in cash immediately and have to make do with invoices, etc. instead. Also, on the other hand, this method may not be able to keep up with a sudden increase in spending by the business where making all-cash payments may prove to be difficult and credit notes may be issued by suppliers to the business, as well.
In this method, which is more commonly used, income is recorded as a transaction without cash actually changing hands. Though this method is used more commonly in accounting, it needs rigorous follow-up to ensure cash eventually follows the invoice or payment agreement. Similarly, records need to be periodically reviewed to ensure business payouts do not turn into liabilities, and eventually bad debt due to non-payment of cash.
Advantages and Disadvantages of the Accrual method:
A clear advantage of the accrual method is that it allows the business to view income and expenses in terms of what is earned and what is spent. This provides a big-picture view to the management, enabling critical business decisions.
The disadvantage, as already touched upon, is that if periodic reviews are not conducted for assessing payment due to the business and payout liabilities, it can prove to be devastating for the business. Moreover, tax liabilities require discharging, and the business will need to stay on top of those.
So which method is better?
The answer depends on the growth goals for the business and its ability to meet them.
Audits for a business are typically possible when the financial statements are prepared using the accrual method, and not the cash method.
Besides, long-term profitability of the business is revealed through income and expense records as listed in the accrual method, without physically waiting for the cash to change hands. Furthermore, there are also requirements, such as the cash flow statement, that reveal the actual amount of cash held by the business.
At Analytix, we have extensive experience with helping small to mid-sized businesses in all aspects of business accounting and operations. We also understand that every business is unique and there is no single formula for quick success. As a result, we review business requirements to gauge what solution would work best. For more information on how we can assist you, call us at 781-503-9004 or email us at [email protected].