When choosing between accounting practices, companies have two primary methods to choose from: Cash-basis vs Accrual-basis. The main difference between cash-basis accounting and accrual-basis accounting is when you record revenue and expenses. Cash-basis accounting recognizes revenue and expenses when cash is received or paid. Accrual-basis accounting recognizes revenue and expenses when it is earned.
What is bookkeeping?
Bookkeeping is a business accounting practice of recording financial transactions in a ledger. Cash-basis and Accrual-basis accounting helps you dictate when you are recording these transactions. Bookkeeping/recording transactions is essential for budgeting as keeping a book of all financial transactions gives the management team insight into the company’s operations and profitability.
What is Cash-Basis Accounting
Following a cash-basis accounting method is friendly to those who have a basic understanding of accounting. The advantages are simple:
- You only record when cash is physically paid (into your bank account or out of it)
- Sole proprietors and small businesses can save money by delaying the hiring of additional staff
- Tracking cash flow is easy
While there are these advantages to cash-basis accounting, using this method might give you a distorted view of your real profitability. Inventoried goods must be accounted for at the start and end of the tax year and a cash-basis method leaves large discrepancies between inventory/accounting and reporting expenses/income. This won’t give an accurate view of the business’ operations and financials. In many cases, services or products are received before payment is made. If you’re only recording revenue and expenses as it comes in, you won’t have a full picture of how much you’ve profited from a particular project or campaign.
What is Accrual-Basis Accounting
Accrual-basis accounting is made up of two accounting features: the revenue recognition principle and the matching principle. Because of these two principles, you’re able to get an accurate view of your company’s operations.
The revenue recognition principle requires revenue to be recognized on an income statement in the period when realized and earned – not when cash is received.
The matching principle requires recorded expenses to best match the revenue they help create.
An accrual-basis accounting method provides a realistic view of income and expenses giving you a long-term picture of the business that cash-basis accounting cannot provide. It also allows you to track inventory in real-time and produce reports for lenders and banks to show the value of the product you truly own.
Cash vs Accrual: What is better for your business?
A cash-basis accounting method is best suited for small start-up companies with no inventory. For a non-publicly traded company, a service-based company, or a company that has an annual gross receipt of less than $26 million (the exception for small-business taxpayers) cash-basis accounting is great and simple.
On the other hand, an accrual-basis method is accepted by General Accepted Accounting Principles (GAAP), while a cash-basis is not. If you are a publicly-traded company that produces, purchases, or sells merchandise with over $26 million in gross profit, you are required to keep an inventory and use an accrual-basis accounting method. Some industries such as Pharmaceuticals and Medical must track and record inventory for compliance reasons so no matter the revenue, an accrual-basis method must be converted to at some point.
Considering lenders and auditors
Owning and running a small business is no easy task. If you are using a cash-basis accounting method, it’s important to note that lenders and auditors will not accept financial statements done with cash-basis accounting so they would need to be converted to accrual if audited. If you are debating between cash vs accrual accounting methods and plan on growing your business in any way, consider following an accrual-basis accounting method.
What is Blue Link ERP?
Blue Link is your all-in-one accounting and inventory ERP solution suitable for small to medium-sized wholesale distributors. With a robust accounting backbone, Blue Link is tightly integrated with its inventory management, warehouse management, order entry and more for a true all-in-one experience. The accounting functionality includes the ability to manage multiple companies, locations and processes as well as retail and eCommerce operations. Blue Link ERP is an accrual-basis system as are many other ERP systems.
Download the Blue Link Buying Guide to help you determine if Blue Link ERP is right for your business.