Timing in business is everything. If it’s not us personally wanting something right now, it’s our customers. That’s where cash based or accrual based accounting method comes in. Queen states it very clearly with the title of their song “I want it all” – as the song states “I want it all, I want it all, and I want it now”. That sums it up!
Don’t get me wrong, I’m not saying that wanting it all and wanting it now is a bad thing. There are just some need to know if you want it all right now or later. This makes a huge impact on how your run your accounting system. You have a choice!
There are two different types of accounting, cash based and the accrual based accounting method, and it is crucial that you know what type your business is using. Due to the fact that it has a direct impact on not only what you see on your financial statements but when you see it. It is your business; therefore it is your decision.
Cash Based Accounting Method
Do you want to see the money you have billed when you actually receive it? Do you want to see the expenses you have incurred when you actually pay the money for those expenses? If so, cash based is the form of accounting you should be using.
Using the cash based accounting method, your Income Statement will show you the income that you have actually received, not billed but received. Meaning that you may have billed a customer in May but not receive payment until July. The income will show on your July statement.
With the cash based accounting method, your Income Statement will show you the expenses you have incurred when you actually pay the expenses, not when you receive the bill from the vendor. Meaning that you may have received the bill from the vendor in June but not pay the bill until August. The expenses will show on your August statement.
Now you may think that cash basis accounting is how you want to run your business. Due to it giving real time numbers, no estimations, you know the money is received and paid out. Read on and see if that still makes sense…
Accrual Based Accounting Method
Do you want to see the money you have billed when you bill it not when you receive it? Do you want to see the expenses you have incurred when you receive the bill from the vendor? If so, accrual based is the form of accounting you should be using.
With the accrual based accounting method, the Income Statement shows the income that has been billed out, not received, but billed. Meaning that you may bill the customer in May but not receive payment until July – the income will show on your May statement.
Using the accrual based accounting method, the Income Statement will show the expenses you have incurred when you are billed, not when you pay the expense. Meaning you may be billed in June but not pay the bill until August – the expense will show on your June statement.
Accrual based is the form of accounting most widely accepted by businesses and accounting professionals. The list of benefits for using this form far outweighs using cash basis; accrual allows the ability to align your income with cost of goods sold providing a true Gross Profit.
In my previous blog “A New View of Financials” I explained the difference between Financial and Management accounting. To use Management accounting, your business HAS TO use accrual accounting, because you have to be able to align your income with your expenses.
Which is Best for Your Business
As stated above, timing is everything. As business owners and managers we have to know where our business is right now and where it is headed. If you do not have that information available to you, you are already behind the times.
Cash basis accounting is reactive. With timing being everything – cash basis does not allow you to prepare for what may be happening within your business until it’s too late.
Accrual based accounting is proactive. Allowing for complete visibility to economic events regardless of when the exchange of cash occurs. Accrual allows current cash inflows/outflows to be combined with future cash inflows/outflows to give a more accurate picture of a company’s current financial condition. Be ahead of the times, use your information and numbers to move your business forward.
Now you may ask “What is the easiest way to find out what form of accounting your financial statements being printed off?“– with most accounting programs, when the report is printed the accounting basis is printed in the upper left hand corner.
Learn what your business is currently using and take control of your numbers. Applied Management Group is here to help with our mentoring and training to move you and your business forward.
The SmallBizRising Blog is designed to be an educational content hub pulling information, best practices and practical advice for the small business owner and features topics including accounting, marketing, technology and more. Be sure to subscribe to stay up to date with new content as it is posted. The blog was created by The Neat Company and receives contributed content from a group of contributing companies that provide technology, services and solutions to small businesses.