CASH OR ACCRUAL ACCOUNTING

Is your business on a cash or accrual accounting basis? You may have had the question asked and were not sure how to respond.

One of the first decisions you will need to make when starting a new business is what accounting technique you will use, cash or accrual. There are differences between the two but primarily the distinctions is the timing of transactions. There are pros and cons to each and you will need to examine examine them before determining which approach to use in your business.

Most small businesses can select their method but others are not able to. Any time your business meets either of the following two criteria, you need to use the accrual method:

• The sales for your business exceed $5 million annually or

• You have an inventory of items that is held for sale to the public along with gross receipts exceeding $1 million per year.

Most small organizations choose to use the cash method of accounting. Under the cash method, income is recognized when it’s received, not when you bill a client. Expenses are similarly recognized when the money is paid out, not each time a vendor bill is received.

Accrual accounting is based on when transactions take place as opposed to when you receive or pay out cash. Even for those who have not yet received the money from a client, income is recognized when the sale takes place instead of when you receive the cash. The same holds true for recognizing expenses; you do so when you receive the goods or services, not when you actually pay for them.

The accrual method of accounting often times will show you a more accurate picture of how your business is performing because it follows the income and debts.   However,  the accrual method does not always give you an accurate image of cash readily available. Not knowing how much cash on hand a business can lead to cash flow problems.

When a business is growing, often times it will have more accounts receivable than accounts payable. Using the cash method in this case would create a decrease in tax burdens, since earnings are recognized only when received.

Choosing which method of accounting to use for your business is a big decision and should be discussed with your tax or accounting professional.