Accrual vs. Cash Basis Accounting

When it comes to accounting models for your small business, you have two basic options: cash basis and accrual accounting. At their core, these accounting models represent two fundamentally different ways to think about revenue and expenses at your business.

Cash basis accounting is the type of accounting that you typically use in your everyday life – simply checking the balance of your bank account or the inside your wallet. The basic principle of cash basis accounting is that, until any cash changes hands, nothing needs to be recorded.

Accrual basis accounting, though, is what most small businesses use to present a more accurate view of the way they operate. It recognizes that, even if no cash changes hands, the operational status of the business has changed. Using the accrual accounting method, your business records revenue and expenses when they’re earned or owed.

While cash accounting is easier and more intuitive, you’re literally just tracking the cash that your business spends and receives. Most businesses require a more powerful, sophisticated form of accounting that takes into account how they match their revenues and expenses. As a result, accrual and cash accounting can present very different views of your business.

Here’s just one example: let’s say you are a medical equipment supplier. As part of running your business, you must maintain an inventory of various medical equipment, pay the rent and utilities of the facility and also pay the staff. You may be paying for these items on a daily, weekly or monthly basis. In return for incurring all these expenses, you also have your customers who pay for repairs on their purchased equipment.

Using cash basis accounting, you would simply record any cash that you spend for auto parts or rent or salaries. And then you would record any cash that you receive from customers when the repairs are completed.

But is that really an accurate view of your business? The truth is that many different variables and factors comprise the overall condition of any small business. Using cash basis accounting, your business would appear to undergo sharp swings in its performance. Some days, it may lose a lot of money, but a few days later, it may make a lot of money.

And what about all that equipment kept in inventory? You’re not using them immediately, but you are treating them as if they are a one-time expense. And what about your customers? What if they are paying using credit or some method other than cash?

That’s where accrual accounting comes to the rescue. It provides a system to match revenue and expenses, so that they are spread out over the time period in which they occur. It provides a system for depreciating assets held in inventory over their entire lifetime. And it makes it possible for a business to truly understand where it stands at any point in time. The core principle is something called the “matching principle” – it recognizes the fact that every expense has some amount of revenue associated with it.

That’s why so many small businesses use an integrated accounting and inventory management software like Spire — it helps a small business owner move to the accrual system of accounting and ties into tax filings as well, which makes things a lot easier every year. So if you still believe that “cash is king,” it’s time to take a different look at your business. Accrual basis accounting gives you a far better view of the underlying fundamentals of your business.

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