Cash vs. Accrual Basis Accounting
Angeal Boone, CPA at Boone & Assoc.
Every business must make a choice between accrual basis and cash basis accounting. This is an important decision, and can be confusing for business owners. There are benefits and drawbacks to each.
With accrual basis accounting, you’ll recognize and pay tax on your income at the time you earn the income, even if you haven’t been paid yet. You’ll also deduct expenses at the time the expenses are incurred, regardless of whether you’ve paid them yet. With cash basis accounting, you won’t recognize or pay tax on your income until you receive the money. You’ll deduct expenses when you actually pay them. Most small businesses and individuals use cash basis.
"When purchasing or starting up a new business, it's always a good idea to consult your tax advisor for specific advice on your particular needs."
In industries such as healthcare, where there can be a gap of two or three months between providing services and being paid, the accrual basis provides a clearer picture of your month to month operations. This is because your financial statements will reflect what you actually earned, rather than what you collected. Using accrual basis may be required by the IRS if your business maintains inventory, or if your sales are over $5 million per year. In addition, if you need audited financial statements, you will be required to use accrual basis accounting. Accrual basis accounting generally provides a more accurate picture of your operations, but does not clearly show the cash flow of the business. This can make it hard to keep track of how much cash you have on hand.
The main benefit of using cash basis is that it is simple and easy to understand. The bookkeeping is very straightforward. However, the timing of cash receipts and disbursements can be somewhat random, so there may appear to be months with unusually high or low profits due to timing, when actually things are quite stable. Cash basis financial statements also give a clearer picture of the cash flow of the business.
When purchasing or starting up a new business, it’s always a good idea to consult your tax advisor for specific advice on your particular situation.