Should you use cash or accrual accounting methods? A lot of business owners don’t realize the difference between the two accrual methods in managerial accounting. Many new business owners and entrepreneurs don’t realize that there is even a distinction. Nearly all accountants and bookkeepers that you come across will know the difference between cash and accrual-based accounting methods (or at least you should how they do), but it can be tough for a small business owner of newly minted entrepreneur to understand the subtlety between the two accounting methods. Here’s a quick explanation that will help you understand the differneces.
Cash Accounting
Cash accounting is basically the simplest method. When you get cash you’ve received revenue and when money leaves your pocket, you’ve incurred an expense. Cash accounting makes sense for super-small businesses that have customers that pay them in person and don’t have do deal with complex supply chains.
Accrual Accounting
Accrual accounting accounts for revenue and expenses at the time the cost is incurred or the revenue is earned. This means that even if your customers don’t pay you until net 30, you will still book the revenue on the day your provided value to them. The same is for costs–when a service is delivered to you you have incurred a cost, regardless of when the money leaves your pocket.
Which Accounting Method is Best?
The answer is, it depends, just stick to one method and you’ll be fine. IRS rules for income taxes are that you must maintain the same accounting method, otherwise they consider it to be non-standard and can subject you to a penalty if you’re audited. Also, consider that publicly traded companies always use accrual accounting methods–which has become the corporate standard.
