Graduating from a small-to-medium sized business to a larger enterprise means business as usual may need to change. This includes how you report on your business income and expenses. While small organisations can choose between cash basis accounting and accrual basis accounting, once you’re a big deal you can’t report your earnings on a cash basis anymore.
Let’s talk more about cash vs. accrual accounting and how to get help if you don’t know how to make the change.
What is cash basis accounting?
If your business has an aggregated turnover of less than $10 million, you can choose to calculate your goods and service tax (GST) using a cash method of accounting. What does this mean? Your internal finance team will only include transactions in tax reporting when money changes hands. In other words, when you make a sale, you’re not responsible for recording it until you actually get paid.
When comparing cash vs. accrual accounting, here are some things to know about cash basis accounting:
- This method of accounting works best for small companies who primarily deal with cash transactions.
- Cash accounting helps you track cash flow and determine what is in your bank accounts.
- If you receive an invoice from a vendor, you don’t record it until you pay it.
- If you send an invoice, you don’t record it until the payment clears.
- Regardless of annual GST, you can use this method if your organisation is a government school, endorsed charitable institution, or gift-deductible entity.
What cash basis accounting can’t show you is the debts that are currently outstanding, and accounts receivable payments that have yet to be settled.
What is accrual basis accounting?
With accrual basis accounting, you track your costs and earnings when they take place, regardless of when you get paid or when you make payments. This type of accounting is required of large, enterprise companies. It can also be good for organisations of any size that don’t get paid right away but want a full financial picture.
Here are key takeaways for the accrual accounting method:
- This method is helpful when tracking a variety of accounts and large amounts of revenue and expenses.
- You can expect the method to be more complicated, because you have to track actual cash on hand plus outstanding income and costs.
- If you complete a service, you report it even if it hasn’t been paid yet.
- If you receive an invoice, it’s recorded as a debt even if you haven’t sent cash yet.
What are the main differences between cash and accrual basis accounting?
Cash vs. accrual accounting differ primarily in the way you keep records and detail your cash flow. Here is a simple breakdown.
Cash basis accounting:
When you are tracking your taxable income using cash basis accounting, you have an accurate idea of your cash flow. You’re only tracking funds as they actually come in and go out, which means your reports are better aligned with cash flow reports. On the other hand, your reports don’t give a full idea of financial health. Your cash flow may look favourable, but you could have thousands of dollars in unpaid costs that are not readily visible.
Accrual basis accounting:
This type of record-keeping is more complex, but also yields a more accurate picture of your total financial earnings and expenses. You’re not tracking just actual funds, but also expected income and costs. If you have a floor installation business, for instance, you would report the project when it’s done — even if the final invoice is outstanding. This doesn’t give you the most accurate picture of real cash flow, since you’re counting income that isn’t on hand yet. The reporting is more complex because you are recording money owed to you and money you owe.
Which one is best for my business?
Either method may work for small businesses, but large businesses should stick with accrual basis accounting. Your internal finance team may need to include a bookkeeping service given how much more involved accrual basis accounting is than simple cash record keeping.
Small businesses can choose between cash basis or accrual basis accounting, with cash basis accounting ideal for businesses that deal in small cash transactions. Larger companies must use accrual basis accounting in Australia by law. But even if you don’t meet the mandatory threshold, you might want to switch to accrual basis accounting to get a better picture of outstanding debts and anticipated income.
Connect with Visory today, and our team of internal finance experts can help you set up accrual-based accounting Wrap up the main arguments and then soft CTA on how Visory can help with setting up your accrual-based accounting.