- May 30, 2022
- Posted by: admin
- Category: Accounting
Accounting helps to develop, and guide your business, and makes it successful. At the beginning of your business steps, you should choose which accounting method you need for your company. There are two basic methods of accounting: cash accounting and accrual accounting.
Cash accounting method
Cash basis accounting is more convenient for small businesses because it’s easy to work with it. In the case of this method, financial transactions are recorded only if they are actually realized. In this regard, the cash method does not conform to the conventions of Generally Accepted Accounting Principles (GAAP). Financial statements which are made on a cash accounting basis contain information about the sources of cash during the tax period, a way of using the cash, and also the cash balances. Besides it being more convenient for sole proprietorships and small businesses, the cash accounting method is also used to manage personal finances. The method has one disadvantage: is that it can show a false picture of a company’s financial health. And it’s especially when transactions, such as unpaid expenses, cash receipts, or outstanding receivables, are not represented in the financial statements.
Accrual accounting method
The accrual method of accounting’s aim is to match income and expenses in that year. As we know transactions are recorded together in the same period. Therefore matching revenues and expenses helps the accrual method to achieve a more accurate measurement of the periodic net income of the business. In the case of accrual accounting, profits are only recorded after they are earned, and expenses are recorded after they are incurred. It implies that an invoice can be recognized as revenue, even though funds are not yet received. When receiving an advance payment under the accrual method, the recognition of advance payment is postponed until the following period when the revenue is earned. It is, however, impossible to postpone beyond the next tax year. As a result, the advance payment must be included in the income in the relevant financial reports and gross receipts for tax purposes.
Due to the accurate picture of the real financial situation of the company, the accrual accounting method becomes valuable in large and complex business entities. For example, the construction firm may pay for a winner construction project after completion of the project. In the case of cash accounting guidelines, the company would not realize revenue until the entire revenue payment is received for accrued many expenses.
Which accounting method to choose? It comes down to the type of your business. Both methods have their benefits. Cash accounting helps to understand your cash flow and is more comfortable for small businesses. The accrual method is suitable for larger businesses. It shows the company’s financial position more thoroughly through informative reports. Before you choose either method for your business, compare the two methods and understand the differences between them so you can find the one that’s the best fit for your business.