One of the most important things your accountant or bookkeeper will need to know and something you need to decide from day 1 is whether you are going to use a cash or accrual based accounting system.
Simply put cash accounting records transactions when you pay or receive the funds. Accrual accounting records transactions on the invoice date. For example you receive an invoice dated 3rd January which you pay on 5th January. In a cash system this transaction would be recorded on 5th January and in accrual based it would be the 3rd.
So, what are the benefits and drawbacks of both?
- Simple method and uses less paperwork
- Suited to smaller businesses. Cash accounting can be a much simpler way for smaller businesses to deal with their accounts as it focuses on what is going out and coming in.
- Doesn’t capture money owed to you or that you owe others. Because the transactions are only recorded when received or paid there, reports may not take unpaid transactions into account.
Accrual based Accounting
- Better suited to businesses which don’t get paid straight away. If your invoice terms are 7, 14 or even 30 days + accrual based accounting may be a better fit.
- Tracks your true financial position. Accrual based accounting accounts for income in the period it was earned and expenses in the period they were incurred.
- More complicated than cash accounting
Now you know how each works what things do you need to consider to choose the best one for your business? Here are the key considerations:
- The size of your business
- The terms on your invoice
- The terms offered to you by your suppliers
- How complicated your business transactions are
- Whether you have the resources to manage accrual accounting
- Which will be more useful for you when looking at end of month reports
If you aren’t sure which would work best for your business, it’s a good idea to talk to a business or accounting professional. Grace offers a complimentary initial consultation to discuss your individual business needs, you can book yours here