Cash vs Accrual Accounting: What’s Best For Your Business?

Managing your business’ finances is key to creating sound business decisions as you grow. In deciding between cash vs. accrual accounting, the following key aspects will guide you. Keep in mind that there is no one answer for all businesses. The accounting method you use greatly depends on your business current needs and future plans.

“Accounting is the language of business.” – Warren Buffet

The famous Wall Street investor is spot on. Despite several business aspects, accounting is its language. Numbers speak on behalf of businesses. Through accounting, we evaluate business performance, compare it with historical results, and stack it up against competitors.

The Importance of Accounting Know-How in Business

In the midst of the pandemic, we understand the importance of accounting knowledge. After all, businesses’ accounting and finance needs are now greater more than ever. With countless companies affected by this unfortunate event, proper financial management is what your business needs to stay afloat.

MPM offers webinars about the ins-and-outs of real-world accounting, finance, and taxation. Learn straight from our founder, Maria Lourdes M. Yanuaria, CPA, CPP, RFP, CFC, as she tackles different accounting aspects for businesses one-by-one. Check which among these scheduled workshops suit your needs the most.

Difference Between Cash vs. Accrual Accounting

The main difference between the two accounting methods is timing. Cash accounting recognizes revenues and expenses once money has been given. On the other hand, accrual accounting records these transactions as they happen, regardless of when payment was made.

Here is an example:

On July 15, your long-time customer purchased 100 pieces of candles from your company, Scent Co. These cost ₱100 per item, for a total of ₱10,000. Rather than paying straight up, you allow your client to settle their balance up until 30 days from today.

As discussed, you receive a check payment on the 14th day of the succeeding month.

Using the cash method, you will record your sale on August 14—the date when you received your customer’s payment.

Meanwhile, if you use accrual accounting, you will record your revenue on July 15. This is when your client placed their order.

Timing of Records

If the difference is simply the date of recording, why is it that big of a deal? Well, the timing of transactions can alter your financial statements by a huge margin. Imagine closing a huge contract in December, to be fully paid in January the following year. Rather than recognizing it now in your books, the sale will have to wait to be recorded next year.

The timing of bookkeeping can impact income tax payments, investor confidence, and even the ease of which you do accounting. Both cash and accrual methods have their advantages and disadvantages. At the end of the day, it is up to you to decide which of the two suits your needs best.

Ease of Bookkeeping

Suffice it to say that cash accounting is much more straightforward compared to the accrual method. Perfect for small businesses with a few transactions, basing your records on cash flow is easy and simple.

Meanwhile, accrual accounting recognizes accounts receivable and accounts payable. This adds a bit of extra work when sales or purchases are made on credit. Nonetheless, proper acknowledgment of unpaid bills and invoices gives a more accurate representation of the current financial position of your business.

If you are both the owner and bookkeeper for your company, it might be better to hire an accountant when going for the accrual method. This way, you can focus on running and growing your business, while your accountant is dedicated to managing your books.

Income Taxes

Despite the complexity of proper computation and filing of tax returns, every business has to comply. There are several benefits to paying the right taxes, among which is knowing that your business contributes to the development of the country. With that said, deciding between cash vs. accrual accounting impacts the amount of taxes your company expends.

Using cash as a basis, your business only has to recognize paid sales when computing for tax. There’s no need to pay taxes for collectibles, giving you smoother cash flow.

On the flip side, using accrual accounting can mean that you are filing for taxes for unpaid income. In such cases, you will have to shoulder the cost of income tax until your customer settles their account.

Financial Projection

Your books provide the best data to project business growth throughout the years. Using cash vs. accrual accounting greatly affect these projections, which in turn influences business judgment.

Since cash accounting fails to recognize payables, you might get a false sense of security thinking you have more spending power. Likewise, without recording receivables, your sales projections are reduced.

Accrual accounting, on the other hand, fares well in providing a long-term perspective towards your finances. Here, incomes and expenses are recognized once made. This makes it easy to identify trends and craft strategies to push the business to further growth. It also shows the effects of client debt and credit to suppliers towards your profits.

External Relations

Finally, choosing between cash vs. accrual accounting influences your business’ dealings with lenders and investors. In business, there will come a time when external funding is necessary to fuel business expansion and success.

Given how cash accounting is not the best choice in predicting future income, external parties prefer the accrual method in evaluating investment opportunities. In fact, accrual accounting is the method prescribed in the GAAP (Generally Accepted Accounting Principles).

With this method, lenders and investors get a better understanding of your company’s financial capacity. Using accrual accounting highlights profitability, making it easier to apply for loans or secure funding.

Putting Your Business in the Center

After learning the different aspects influenced by your choice of accounting method, put your business towards the center of your decision-making. Evaluate your current needs and financial standing.

More importantly, think about your vision. Where do you see your company in the next 5 years? 10 years? Your answer to these questions will help you settle on which accounting method works best for your business.

Quick and Easy Accrual Accounting

Keep in mind that shifting towards a different accounting method can lead to further inconvenience in the future. If you believe in your business and its potential, start using the accrual method now and use it as you grow.

Dedicated software like MPM Accounting helps companies like yours manage their financials digitally. With a team of experts ready to support your needs, you get worry-free accounting and bookkeeping with more time to focus on your business.