When it comes to running and scaling your business, you must have a robust accounting system in place that helps you keep track of everything that comes under the umbrella. The decision as to which type of accounting method to go with is itself debatable and has much to do with the future of your business.
If you are confused in deciding the right accounting method for your business, this article is specifically focused to help you decide!
Choosing the Right Accounting Method for your Business
Primarily, there are two accounting methods —The Cash Method and the Accruals Method. In order to decide which one to choose, let us quickly have a look at both of the accounting methods.
In the Cash Method, businesses consider cash flow while recording a transaction and all bookkeeping simply follows the cash. The business will record a transaction as soon as they pay or receive cash and therefore, it is a simpler method of accounting.
For example, when a business makes a credit sale, it will not be included in the financial statements until the customer actually pays and the same goes for expenses.
Contrary to the Cash Method, the Accrual Method does not consider cash flow and records transactions as soon as they are incurred. The Accrual Method combines both the rules of “Matching Concept” and “Revenue Recognition Principle” since an expense is matched to the period to which it belongs and revenue recognized as soon as it fulfills the criteria. Businesses with inventory are almost always required to use the accrual accounting method.
For example, if a business makes a credit sale, it will record it in the period regardless of whether the cash has (or hasn’t) been received in the period.
So, Which is the Right Accounting Method?
Neither the cash nor the accrual method is the wrong accounting method and both of these accounting methods have pros and cons. In addition, some businesses are restricted to use the cash accounting method. Therefore, before deciding on which one to go with, you need to know whether your business actually has the choice!
If a business has annual gross revenue of >$25 million, then it has the option to choose either of the accounting methods but if the revenue exceeds $25 million, then the business must use the accrual method. Also, if the business is a publicly listed company, then it must use the accrual method and cannot opt for the cash method.
Generally, the cash-based accounting approach is specifically suitable for small businesses that heavily relies on cash flow meaning that much of the revenue and expenses are cash-based. On the other hand, the accrual method is a more general approach and works best for both small and large businesses. In fact, it makes the bookkeeping more transparent and harmonized thus making it simpler for external accountants across the globe to analyze the performance of the business.
Therefore, if you have expansion plans, it is advisable to use the accrual method since it makes the accounting process much standardized. If you need help in deciding whether to choose the cash-based or accrual method, we at Citrine Accounting and Taxes, are here to help! Call us to schedule a virtual or in-person appointment. We service the area in and around Avondale, AZ. As a ProAdvisor, I use Quickbooks to manage all your financial needs.