There are two different types of accounting: cash basis and accrual. These methods differ in some ways, but both will give you some kind of overview of your business finances and the health of your company. Which one is right for you largely depends on you, your accounting knowledge, and the needs of your business.
Cash Basis Accounting
Cash basis accounting is popular with small businesses because of its simplicity. With cash basis accounting, you record incoming and outgoing cash as it comes and goes. When a customer pays for a product, it gets recorded. When you pay a vendor, it gets recorded. When you bill a customer or are billed by a vendor, however, it is not recorded. There is no tracking of accounts payable or receivable, so there is less to worry about when it comes time to run the numbers.
- It’s a simple system that is easy to learn and manage.
- Gives an excellent short-term overview of business health.
- Does not comply with generally accepted accounting principles (GAAP).
- No long-term overview of business health.
Accrual accounting is much more complex because it factors in accounts payable and receivable, which means there are more numbers to crunch. When you pay a vendor or get paid, that gets recorded just like with cash basis accounting. However, it differs in that it records whenever you bill someone or are billed by someone which shows longer-term financial comings and goings.
- Complies with GAAP standards.
- Shows a better overview of total business health.
- Significantly more complicated than cash basis.
- Does not give an overview of short-term finances.
Which is Better?
Which option is better for you depends largely on your business and what you need your accounting to do for you.
Cash basis can be easily picked up and utilized by any small business owner that needs a quick way to keep track of immediate finances. It doesn’t require a lot of time to manage and monitor cash basis accounting, and its simplicity makes it accessible and favorable to small businesses. The problem, however, is that cash basis cannot go with you if your business grows past a certain point or becomes publicly traded.
Companies that are publicly traded or are making $25 million or more annually are required to comply with GAAP standards and use accrual accounting, regardless of which they prefer. Accrual accounting gives a better overall and long-term view of the business’s financial health which is important for stockholders. If you’re a small business that could breach the threshold, it’s important to learn how to manage accrual accounting in case you need to switch over due to company growth.
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