Cash-basis vs Accrual-basis
Choosing between the cash-basis and accrual-basis methods of accounting depends on your business's size, complexity, and specific needs. The core difference is the timing of when you record revenue and expenses.
Cash-basis accounting records income and expenses when cash actually changes hands.
Accrual-basis accounting records income when it's earned and expenses when they're incurred, regardless of when money is received or paid.
When to Use the Cash-Basis Method
The cash-basis method is simpler and easier to manage, making it ideal for certain types of businesses.
Small Businesses and Sole Proprietors: The IRS generally allows businesses with less than $29 million in average annual gross receipts (for the three preceding tax years) to use this method.
Businesses Without Inventory: This method works best for service-based businesses like freelancers, consultants, or real estate agents, where there are no goods to track.
Focus on Cash Flow: It gives you a clear, real-time picture of the cash you have on hand, which can be critical for day-to-day cash flow management.
The main benefit is its simplicity. It's a straightforward approach that mirrors your bank account activity.
When to Use the Accrual-Basis Method
The accrual-basis method provides a more accurate and comprehensive view of your business's financial health, making it the standard for most growing companies.
Businesses with Inventory: If you sell products and have inventory, you are generally required by the IRS to use accrual accounting to properly match sales with the cost of the goods sold.
Publicly Traded Companies: All publicly traded companies must use accrual accounting to comply with Generally Accepted Accounting Principles (GAAP).
Businesses with Significant Accounts Receivable or Payable: If you frequently buy or sell on credit (i.e., you have customers who pay later or vendors you pay later), accrual accounting is essential. It tracks the money owed to you (accounts receivable) and the money you owe others (accounts payable), providing a full financial picture.
Seeking Investors or Loans: Lenders and investors prefer accrual-based financial statements because they show a more accurate and complete view of a company's profitability and long-term viability.