1.3 – CASH VS ACCRUAL ACCOUNTING

Many small business owners record their transactions using cash-basis accounting, but could the accruals method be more appropriate? Learn the difference so you can make better accounting decisions for your business.

Cash vs. accruals accounting often confuses clients, as either method can be used for different purposes, such as tax, GST or overall accounting. Business owners need to understand the difference and be aware of the implications of each method to decide which approach is best for their business.

Difference between cash and accrual accounting
Cash accounting is recognising the income and expenses in your business when they are physically paid rather than on receipt or issue of an invoice. Many business owners when starting out often use a simple, basic cash system, because it helps to keep track of cash flow.

An accrual accounting system recognises both income and expenses on receipt of an invoice or bill although not yet due for payment. This system will create debtors and creditors in your accounting software, showing what you owe and when, as well as funds owed to the business from your customers. In today’s tough business environment it is more important than ever to monitor your debtors closely and have a good system in place to reduce the number of days awaiting payment or, worse still, avoid it becoming a bad debt that has to be written off.

The benefits of accrual accounting
I believe there are greater benefits for small business owners of using the accrual accounting method. Not only does it help them understand their business better by highlighting their true financial position, but, more importantly, it highlights the cash-flow effects of collecting debtors and paying creditors.

To see these benefits it helps to compare your business situation to a personal one.

Consider this: When it comes to your household utilities, when do you recognise your debt? Is it when you receive the electricity or telephone bill; is it on receipt of the invoice, or is it when you pay bill?

In the context of your personal accounts, it makes sense to recognise the debt when the bill arrives to help you keep track of money that you have and don’t have, no matter the account figures. The same goes for your business accounts.