As a franchise or small business owner, you’re in charge of making countless decisions, and how you handle your accounting is one of the most fundamental.
Small business owners often find themselves weighing the merits of cash basis accounting against accrual accounting.
So, let’s break down these concepts to help you decide which method would best suit your business needs.
What is Cash Basis Accounting?
Cash basis accounting is straightforward: it records transactions when money changes hands. This means income is noted when it’s actually received, and expenses are documented at the time they are paid out.
This simplicity makes it a popular choice among small business owners, especially those who prioritize a clear, immediate view of their cash flow.
Advantages of Cash Basis Accounting
- Simplicity: It’s easy to implement and maintain, ideal for those without extensive accounting knowledge.
- Clear Cash Flow View: Provides an accurate picture of how much cash is actually available at any given time.
- Income taxes: Income isn’t taxed until received. Ex: If an invoice isn’t paid until the next year – it is not taxable in the current year.
Disadvantages of Cash Basis Accounting
- Limited Financial Overview: It doesn’t account for money that is owed but not yet received, or expenses incurred but not yet paid, potentially giving a misleading picture of financial health.
- Growth Limitations: As businesses grow, they may need more sophisticated methods to manage finances, which cash basis accounting cannot provide.
- GAAP Non-compliance: Does not adhere to generally accepted accounting principles, limiting its use for larger businesses.
What is Accrual Accounting?
Accrual accounting is more nuanced. Income and expenses are recorded when they are actually earned or incurred, regardless of when the money is actually exchanged.
This approach gives a more accurate picture of a company’s financial health by recognizing accounts receivable and payable.
Advantages of Accrual Accounting
- Comprehensive Financial Picture: Offers a more accurate view of a business’s financial health by including all assets and liabilities.
- Improved Decision Making: Helps in planning and forecasting by showing the real-time financial position of the business.
- Compliance and Growth: Facilitates compliance with financial reporting standards and supports business growth and scalability.
- Tax Deductions: Tax deductions can be maximized by deducting early-paid bonuses in the next tax year.
Disadvantages of Accrual Accounting
- Complexity: Requires a more sophisticated understanding of accounting principles and is more complicated to implement.
- Potential Cash Flow Misrepresentation: Without careful management, it can give a false sense of security about the business’s cash position.
Choosing the Right Method for Your Business
When deciding between cash and accrual accounting, consider your business’s size, financial complexity, regulatory requirements, and growth plans. Ask yourself:
- How important is a clear, immediate view of cash flow to my daily operations?
- Do I have the resources to manage accrual accounting?
- What are my future plans for scaling the business?
Still not sure? A good rule of thumb is to remember…
Cash Basis Method: Suitable for businesses that:
- Earn less than $25 million annually.
- Do not sell products directly to consumers.
Accrual Method: Required for businesses that:
- Exceed $25 million in annual sales.
- Are publicly traded.
Ceterus As Your Small Business Bookkeeping Solution
Overwhelmed with what the accounting methods mean for your business? Don’t worry. This is what we wanted to do on career day. Not you.
We offer tech-enabled bookkeeping services and tax preparation that can help small business owners and franchisees manage their finances more effectively.
With Ceterus, you can expect:
- Brand-compliant financial statements
- Timely transaction updates
- Peer benchmarking
- Ongoing tax advisory services
- Multi-unit reporting
- Cash flow projection
- Dedicated financial consultations
Schedule a consultation to learn more about how we can help you!
