Should You Choose Cash or Accrual Accounting for Your Small Business?

June 7th, 2013 by

Starting a small business comes along with all kinds of decisions. Some of the most important decisions you’ll make about your small business involve your finances. How you account for your cash and what you do with your money are, after all, some of the most important aspects of running a small business. Of all the financial decisions you can make, one of the most important is whether you’ll operate under the cash or accrual accounting method.

Each method has its pros and cons that you may wish to consider before making a firm decision.

Cash Accounting Method

Using a cash accounting method can help you keep tabs on your cash flow when you’re checking your books. Under a cash accounting method, you only record transactions when cash has changed hands. For example, if you sell pizzas, but one of your loyal customers, Jimmy, orders a pizza and doesn’t pay for two months, you don’t record the sale until he actually pays you. Cash accounting can be a great way to keep track of your actual cash flow, since you’re not concerned with transactions (from an accounting viewpoint, anyway), until you’ve actually received payment or paid a bill.

Accrual Accounting Method

Accrual accounting, on the other hand, is more concerned with when transactions happen. Under this system, Jimmy’s pizza would be recorded when the pizza is sold, and not when he actually pays you. If you let your customers pay you later, and record the amount as accounts receivables, you’re probably already practicing accrual accounting.

Choosing Between the Two Methods

While there are advocates for both type of accounting, in general, small business owners tend to use accrual accounting methods. Why? Because most small business accept payments after services have been rendered, or offer credit to their customers and clients. Accrual accounting methods help you see the bigger picture, including money coming in and going out in the future, not just today.

Plus, the government requires many businesses to use accrual accounting. If you’re running a C corporation, you’ll need to use accrual methods for keeping track of your finances. Companies that carry an inventory are also required to use accrual accounting. For example, if you sell tires and you keep a warehouse full of different tire options, then you’ll need to use accrual accounting. Finally, companies that have a gross sales revenue of over $5 million need to practice accrual methods of accounting.

A Pittsburgh Tax Professional Can Help You

Accrual accounting can be a much more difficult process than cash based methods of accounting. That’s because there are many more moving pieces and points of data to track. However, an experienced and professional accountant will be able to help you keep track of your finances and can prepare reports and forecasts to help you make decisions.