top of page

Are You Using the Right Accounting Method?

Expenses and revenue are common to all businesses, but how you account for the money that flows into and out of your business is a matter of choice, or in some cases, federal regulations. The two main methods of accounting used in the U.S. are cash basis or accrual basis accounting. They each have their own advantages and disadvantages. Here’s a quick primer.

sign with arrows, bag of cash, calculator

Cash-basis accounting is the simplest method to track your numbers. Simply put, when money is received (cash receipts) or goes out (disbursements), it is recorded. Think of it as a real-time cash flow picture, most accurately reflecting your actual cash balance at any given time.

Accrual accounting, rather than tracking your cash inflows and outflows, looks at what you owe and what is owed you. In other words, when a customer places an order, that future revenue is counted as accounts receivable (A/R). Similarly, when you incur a debt to a vendor or creditor, what you owe is recorded as a liability or accounts payable (A/P).

Cash-basis accounting is very straightforward and relatively simple to use. For sole proprietors and small businesses who are more reliant on cash flow, this method makes sense. Moreover, if your business falls under a $25 million cap, the IRS has made it easier for you to use the cash-basis method.

However, what a cash-basis method fails to do is account for all the income you’ve earned or consider expenses you owe. This may make it difficult for potential investors, lenders, or even you as a business owner to grasp the true health of your business.

Larger businesses, due to their size and complexity, often need to rely on the accrual method to accurately track a more complicated and broad business accounting picture. Accrual accounting does a better job of tracking pending credit card payments and any inventory or short-term investments. 

Furthermore, public companies must comply with the standards set by GAAP, Generally Accepted Accounting Principles, under the guidance of the Financial Accounting Standards Board (FASB). The accrual method meets those requirements, while cash-basis accounting does not. All that said, accrual accounting requires much more detailed accounting and considerable time and effort. For companies that use this method, outsourcing accounting support may be a smart move.

Just because you may have started out with cash accounting does not mean it is the right accounting method for your business today. We’ve helped many businesses evaluate their accounting systems and assisted with making the switch. Let’s talk.


Commenting has been turned off.
bottom of page