When you first start your business and begin recording business transactions, you must decide whether to use cash basis or accrual basis accounting. The big difference is in how you record your cash transactions. Many people use cash basis accounting for taxes and accrual basis for managing the business. Here are 5 things you must know when considering which to use.
- Cash basis accounting means you record all transacations when cash changes hands (revenue and expenses). Cash basis does a good job of tracking cash flow, but a poor job of matching revenue with expenses. Accrual basis does the opposite, it does a great job of matching revenue and expenses, but a poor job of tracking cash flow.
- It’s difficult to use cash basis accounting if you buy or sell on credit because you may have revenue or expenses with no offset until a later period.
- Many business owners use accrual basis accounting to manage their business because it does a good job of matching revenue and expenses even if no cash changes hands. This becomes even more important as the business grows.
- Many companies that use accrual account will use a cash flow report to monitor cash on a weekly basis to be sure they have enough cash on hand to operate the business.
- Should your business be on an accrual or cash basis for your tax return? The answer is “it depends.” The quick answer depends on whether your selling terms are to pay immediately. You want to have expenses to offset the revenue, so you might elect the accrual basis. However, if your business sells on credit, but incurs cost before revenue is received, then cash basis might be better. Please consult your CPA for specifics before landing on an answer.
To manage your business effectively, you need to be sure that you’re profitable. So, accrual basis financials that match revenue and expenses are critical. However, you also need to be mindful of what cash you have in the bank and what bills need to paid this week/month. Therefore, a cash flow report is needed to manage that effectively.