Accounting methods can be extremely tricky for business owners who are new to keeping their records. Cash basis accounting and accrual accounting are both very common practices, but which one is right for your business? You need to know the ins and outs of both types of accounting to determine what the right move is for your business finances.
If you want to learn more about how to track your finances, this quick overview will give you a better idea of what to do.
Cash Basis Accounting
Cash basis accounting is often the easiest way to track revenue for a small business. In this form of accounting, you recognize transactions only when they occur. You mark down revenue as it is received and expenses only when they are paid. Accounts receivable or accounts payable are not recognized with cash basis accounting.
Many people like this method of keeping track of their finances because it gives them a clear look at exactly how much cash is in their bank account at any given time. The balance is clear without any pending transactions to consider. Another benefit is that your income is not taxed until it is officially in the bank and recorded.
While cash basis accounting is typically easiest, accrual accounting is actually more common. Accrual accounting records revenue and expenses whenever they are earned. For example, you may count on receiving money at the end of a large project even if you have not actually been issued a cheque yet. The transaction is recorded as soon as that project is finished instead of when the money comes in.
Cash basis accounting gives you a clear picture of exactly what is in the bank. On the other hand, accrual accounting gives you a more comprehensive look at your finances. It can tell you how much money is due to you and how much money you will soon have flowing out to cover your expenses. Unfortunately, it does not account for how much money is actually in the bank so you must be conscious of monitoring your actual cash flow simultaneously.
When to Use Each Method
If your business is a corporation with a high annual receipts total, then the accrual method may be the better fit for you. The general rule is that you should use the accrual method if you’ve totalled more than $25 million in gross receipts over the past three years. If your business is not a corporation or does not have this much in sales, then the cash method may work just fine for you especially if you do not carry inventory.
Getting a Professional Opinion
Sometimes, it can help to get a professional opinion on what you should do with your accounting. Contact an accounting firm in Winnipeg so that you can get a good idea of what method will work best for you and receive help if you want to switch. Compass Accounting would love to assist you!