Accounting is part of business operations
to keep track of all business transactions. Business transactions are of
various natures there will be income and expenses. The income can be earned as
products sold and services provided on a credit basis or it might be the case
that the product and services are sold for cash. There are two main small
businesses accounting strategies cash and accrual basis of accounting. Small
businesses can opt for cash or accrual basis of accounting based on their
business operations and the nature of the business.
Further, the income could be of primary business
activity of assets revelation gain or loss or other income. Expenses also are
of a different nature; they might be related to operational expenses or
financing activities etc.
There are expenses such as meals and
entertainment, and a recurring subscription that is paid when due this is
while others might be credited initially and paid for later.
Account Payable and Account Receivable in Cash vs
Accrual
So, the income and expenses are not received
and paid when it's due but there might be a creditor/payable and
debtor/Receivable in every business. If the business is a managing account
payable and account
receivable it is using an accrual basis of accounting to manage
While doing bookkeeping for your small
business you can use this small business accounting strategy you can choose
between two different account methods known as cash and accrual bases of
accounting Accrual
Basis of accounting fie small business.
On an accrual basis of accounting income is
recorded when earned and expenses are recorded when incurred irrespective of
whether cash is received or paid or not.
The accrual method of accounting follows the
famous accounting principle called the matching principle, which states that an
entity should recognize revenues and expenses in the same period. It also
follows the revenue recognition principle, which states that organizations
should recognize income/revenue when earned.
To match the records there might be more accounts
under this method, for example, account receivable and payable.
On an accrual basis, you can manage Accounts
receivable and payable for revenue and expenses that are not yet received or
paid. You can create an Invoice or bill to track these incomes and expenses.
When business operation expands it becomes the
need of your small business to use an accrual method of accounting. It shows the
income and expenses detail correctly and as per the statutory obligation and it
shows the correct picture of your assets and liabilities to date.
Advantages
of accrual basis of accounting for small business
The accrual basis of accounting represents a
clear picture of business assets and liabilities. This is one of the reasons
this is the preferred accounting method. Small businesses and new startups must
use an accrual basis of accounting because investors usually prefer the accrual
basis of accounting because of its clarity. Cash Basis of accounting for small
business on a cash basis of accounting you can only record when income in
cash is received and expenses are paid.
Advantages
of cash basis of accounting or cash accounting
1. Few
accounts: When you adopt a cash basis of accounting you have to recognize
income when received and expenses when paid there will be two accounts involved
cash/bank will be debited and credited and income will be credited and expenses
debited there are no other accounts such as keeping a record of creditor and
debtor or account payable and receivables so there are fewer accounts and less
complexity.
2. Easy
to understand: by debiting and crediting the cash account and respective income
and expense account one will easily understand and do it.
3. Takes
less time
Disadvantages
of cash basis of accounting
The disadvantage of cash-basis accounting is
that it doesn’t provide all the information about income and expenses. The cash
basis of accounting doesn’t show future payments and receipts, so it
understates the assets and liabilities of the entity. Limited use Not all
businesses can opt to use cash-basis accounting. The entity having credit sales
and purchases can’t use the cash accounting method:
·
Sell products or services on a credit
·
Have gross receipts higher than the
IRS requirements
·
Need inventory management
Disadvantages
of Accrual Accounting
Accrual accounting is typically seen as more
time-consuming and difficult to understand compared to cash accounting.
Additionally, accrual accounting can skew the financial performance of the
company. Consider if you made the sale and haven't yet received payment for
that this will show the sale has been made and cash and bank have not been
debited yet.
Organizations have a very limited role choice
in choosing between accrual and cash accounting. Cash accounting is likely to
be the preferred method for small entities. GAAP-compliant entities are
required to use accrual accounting. IFRS and GAAP roles state that mid and
large-size entities must follow the accrual basis of accounting.
So that the stakeholder and the user of the
financial report or financial statement get the full picture of the company's
complete assets and liabilities. The
investor is external users who usually prefer an accrual basis of accounting.
So, to avoid any inconvenience and probable shifting of small entities we must use
an accrual basis of accounting.
The best strategy for small businesses is to adopt an accrual basis of accounting
Also, when an organization grows larger it has
business operations not only in cash but on credit as well and is bound by GAAP
and IFRS to use the accrual basis of accounting. It is a better strategy for
small businesses to adopt an accrual basis of accounting at the early stages of their
business to remain up to the laws and IFRS and GAAP regulations and have a clear
understanding of business finances. Also, this small business accounting
strategy will help you avoid the future hassle of shifting and adapting to the accrual
basis of accounting from the cash basis of accounting.
Useful
Resources
Bookkeeping
Basics for Small Business Owners
What
is a Chart of Accounts? How to Set a Chart of Accounts?