When it comes to managing your business finances, the foundation of good decision making is having the right information, at the right time. All companies must adopt an accounting method that aligns with their operational needs, regulatory requirements, and long-term financial strategy.
- What is Cash Accounting?
- Why Businesses Love Cash Accounting
- What is Accrual Accounting?
- Why Businesses Love Accrual Accounting
- Which One Should You Choose?
The two primary accounting methods for any business are ‘cash accounting’ and ‘accrual accounting’. Each has their own perks and quirks. So, which one is the best fit for your business?
Our experts at MontPac break it down below in simple terms:
What is Cash Accounting?
Cash accounting is as straightforward as it sounds, you record money when it actually changes hands. If cash hits your bank, it’s income. If you pay a bill, it’s an expense. No waiting, no guesswork. It’s mostly suited to small businesses that want to keep things simple.
Why Businesses Love Cash Accounting:
- Easy to Use: No fancy calculations, Cash Accounting simply states all cash coming in and going out.
- Clear Cash Flow Reporting: You always know exactly how much money you have on hand.
- Lower Tax Burden: You only pay taxes on income you’ve actually received, which can help reduce your tax liabilities.
The Downsides:
- Not the Full Story: Since it doesn’t track company liabilities, there is no way of telling how much of the cash in hand can be actually utilized for operating expenses.
- Less Useful for Growth: If you’re scaling up or seeking investors, cash accounting will become nothing more than another hurdle to jump before your business can grow.
- Profitability Can Be Misleading: Just because you haven’t been paid yet doesn’t mean you aren’t earning, and vice versa.
What is Accrual Accounting?
Accrual accounting takes a more forward-thinking approach, recording income when it’s earned (even if you haven’t been paid yet) and expenses when they’re incurred. It provides a deeper, more accurate view of your business’s financial performance, making it MontPac’s go to method for any business looking to scale and grow.
Why Businesses Love Accrual Accounting:
- An Accurate Financial Picture: It tracks all revenue and expenses (regardless of whether cash has changed hands or not), giving you a more accurate snapshot of your profitability.
- Investor & Lender Appeal: Accrual accounting aligns with financial reporting standards (like GAAP and IFRS), making it a must for most investors and lenders.
- Better Financial Planning & Analysis: By recognizing transactions when they happen, you can make smarter, data-driven decisions to help your business succeed long term.
The Downsides:
- More Complex: It requires a bit more effort and technical accounting to track revenue and expenses accurately.
- Making the switch: It can be extremely difficult to change over from Cash to Accrual accounting system. Leaving a potential for errors in future reporting.
- Less Immediate Cash Visibility: Since revenue is recorded before money is in the bank, businesses need to have more focused awareness on cash flow management.
So, Which One Should You Choose?
If you’re a small business with simple finances and want to keep things easy, cash accounting may just be your best bet. But if you’re looking to grow, pursue outside investment, or get a clearer financial picture, accrual accounting is most definitely our recommended way to go.
At MontPac, we have 20 years of experience helping businesses navigate these decisions with ease. Whether you’re keeping it simple with cash accounting or stepping up to accrual accounting, our team is here to guide you every step of the way. Get in touch today to see how we can help your business thrive!