There are two primary accounting methods: cash and accrual accounting. The accounting method you choose will affect many aspects of your business, including how you report on business income and expenses.
Small organisations can choose between accrual and cash basis accounting. However, publicly traded companies must use accrual.
Additionally, once your business revenue reaches $10 million, you’ll need to use accrual accounting and calculate your goods and services tax (GST). Small businesses with large inventories may also benefit from it.
Let’s talk more about cash vs. accrual accounting and how to get help if you don’t know how to make the change.
Table of contents
- What is accrual basis accounting?
- How does accrual accounting work?
- What is cash basis accounting?
- How cash basis accounting works
- What are the main differences between accrual and cash basis accounting?
- Accrual accounting or cash: Which one is best for my business?
What is accrual accounting?
With accrual accounting, you track your income and expenses when they take place, regardless of when you pay bills or receive payments. For example, you’d record an invoice when you send it, even if your client hasn’t paid yet.
Accrual accounting uses a double-entry system, meaning that you track twice, once for debits and another for credits. Double-entry can help prevent fraud and give you a more realistic view of your cash flow.
Organisations of any size can use it. It provides a more complete financial picture, even when you don’t get paid right away for your products or services.
Here are the key pros and cons of the accrual accounting method:
|It’s helpful when tracking a variety of accounts and large amounts of revenue and expenses.
|It’s more complicated because you have to track actual cash on hand plus outstanding income and costs.
|Making financial projects and planning for the future is easier.
|Financial reports may need adjustments for as-yet-unpaid amounts when discussing current balances.
|By logging cash flow with double entries, it’s simpler to catch mistakes or fraud.
|Bookkeeping and accounting may be more time-consuming.
|It meets acceptable accounting practices and is the standard for public companies.
|You could end up paying taxes on income that clients and customers haven’t paid you yet.
How does accrual accounting work?
Accrual-based accounting is an accounting method that tracks all outstanding credits and debts as if they have already happened.
If you complete a service, you report it as though you’ve already been paid in your books. Then you debit any invoice totals even if you have not cut a cheque yet. You can see all of your transactions—including long-term, future ones—in one place.
What is cash basis accounting?
Businesses that have an aggregate turnover of less than $10 million may use cash basis accounting to calculate goods and services tax (GST).
Your internal finance team will only include transactions in tax reporting when money changes hands. In other words, when you make a sale, you don’t have to record revenue until you actually get paid.
Regardless of annual GST, approved government schools, charitable institutions, and gift-deductible entities can use cash basis.
Here are some pros and cons to consider:
|It works best for small companies that don’t have long payment cycles.
|Cash basis accounting can’t show you the debts that are outstanding, and accounts receivable payments that you haven’t settled.
|Cash accounting helps you track cash flow and determine what is in your bank accounts.
|You may not be prepared for incoming invoices from vendors or suppliers.
|It’s simple because you only record transactions at the time they occur.
|Not all businesses can use cash accounting.
How cash basis accounting works
With cash basis, you only track transactions when they happen. Each time your company makes a profit, you add to your total revenue.
When you receive an invoice, you subtract. What it can’t show you is upcoming debts. These may include monthly accounts receivable cheques or recurring bills.
What are the main differences between cash and accrual basis accounting?
Cash vs. accrual accounting differs primarily in the way you keep records and detail your cash flow.
It’s easier to track with cash accounting because you only track funds when they come in and go out. However, it doesn’t show the full picture of your financial health. Your cash flow may look favourable, but you could have thousands in unpaid costs that are not readily visible.
Accrual is more complex but also gives you a more accurate picture of your finances. You’re not tracking only 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.
Cash or accrual accounting: Which is best for your business?
Either method works for small businesses, but large businesses should stick with accrual. Your internal finance team may need an online bookkeeping service to help with accrual accounting.
|When to use cash basis accounting
|When to use accrual accounting
|You have a simple revenue stream with little time between invoices and payments
|You have complex revenue and cash flow
|You value short-term cash flow over long-term projections
|You need to know your cash flow total including future projections
|You generate less than $10 million a year
|You generate more than $10 million a year
Small businesses can choose between the two accounting methods. 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 to get a better picture of your business finances.
Connect with Visory today, and our team of internal finance experts will get to know your business and which accounting method is right for you. You’ll partner with a team dedicated to your accounting needs and be able to access your books in real-time.