Greetings future leaders of the accounting world. Let’s dive into an exciting and pivotal topic for anyone delving into the world of bookkeeping and financial reporting: the cash and the accrual method of accounting. In this article, let me explain these two accounting methods in and out and differentiate between the subtle details that set one method apart from the others and make the difference when it comes to choosing what method is best for a business.
What is the Cash Basis of Accounting?
Lastly, to commence with, the cash method of accounting is as if you have a piggy bank for the business cash. Your business recorded its revenues, including all associated expenses too only once you collect the cash or pay out the cash. It’s incredibly easy to use, which is why it can be considered ideal for startups or freelancers. Here are some pros and cons of the cash method:
Pros
Ease of implementation: Some of the reasons that have made the cash method favourable to beginners are; The cash method does not involve many complications thus does not need to address the implied complexities.
Simplicity: It is simple, meaning you spend less time on accounting operations, which means you can dedicate time on making your business grow.
Less paperwork: It means that you may have to produce fewer financial documents, which makes it easier for you to manage your paperwork.
Cons
Delayed recognition of revenue: Revenue acknowledgment is not immediate, only when the revenue is expected to be received, therefore delaying the growth recognition.
Inaccurate cash flow: However, the use of cash method is challenging from the perspective of preparing an accurate cash flow forecast as it does not capture unpaid invoices or bills.
The Accrual Method of Accounting
On the flip side, the accrual method of accounting is based on the principle of “money speaks where you record revenues and expenses when they accrue in the given fiscal period rather when received or paid” The sources of accrual based revenue recognition are as follows: Sometimes this approach may seem very complex as compared to the other but it gives a better picture of a business house financially. Here are some pros and cons of the accrual method:
Pros
Timely recognition of revenues and expenses: Since it captures transactions as they accord, you can offer a better representation of financial performance of the business.
Improved cash flow management: Standard accrual accounting give better insights into your company cash flow regulating your investments and expenses better.
Better inventory management: The accrual method of accounting enables you to have a correct figure of the actual cost of the products on the shelves, and this will assist you in making the right purchase.
Cons
Complexity: This is because accrual method involves a number of financial concepts and hence it is difficult to apply if one is learning it for the first time.
Increased paperwork: More sales should be documented, resulting in a greater amount of documentation.
Choosing the Right Method for Your Business
If you are wondering which of the two methods is right for your business you are in the right place. In the end, the choice between the cash and the accrual method of accounting is more about your type and objectives of a business.
Here is where the cash method of accounting may be ideal for small businesses, and freelancers who do not have time, or interest or, the capability to deal with a acute level of complication. On the other hand, if you want a more realistic picture of the state of your business, the accrual method becomes preferable, especially for the mid and large-sized enterprises.
Conclusion
Well, there you have it! Cash vs . accrual accounting methods, examined and discussed. Though estimating cash received and paid might be suitable for small-scale businesses, the general method called accrual is far more suitable for providing correct information about the financial standing of the company. In choosing between one instrumental method over the other, always keep in mind that your business comes first and the goal is the long-term sustainability of the company. Good luck and luck to your accountancy!
