Cash vs. Accrual

We’ve got a present of sorts for you! 

We’re going to talk about accounting, and we won’t make you do math! 

Accounting isn’t exactly the sexiest of subjects, but it should be because it’s at the very heart of your business. It’s the way you measure your health and performance, and it’s quite literally the vehicle that makes everything in your operation happen. 

I’d like to start with a question, but I don’t want you to be afraid of the answer.

Are you a cash-basis business, or do you like the accrual method?

If you’re not sure – don’t be embarrassed! Many small business owners are so focused on just getting their work done that they don’t have time to think about the nuts-and-bolts of number crunching – that’s the accountant’s job! 

There are, however, some important differences between the two methods, and as you continue to become the business mogul that you are destined to be, you should definitely consider the pros and cons of each. Let’s check them out!

Cash Basis Accounting

How it works – It’s pretty simple, and chances are you’re operating on a cash-basis system in your personal life right now. Revenue is recorded when it comes in – When you cash the check, it goes in the ledger as revenue, and it doesn’t matter if they’re paying you for something they bought right then, or a debt from a few weeks back. When it hits the account, that’s when and where you see it. 

Expenses are recorded the same way – When the money leaves your account, that’s when it goes on the books. You could buy something today, or you could be paying off an order that you made six months ago. Just like your bank account, the money is in the account until that moment when it leaves. 

It’s a pretty straightforward system, and if it’s not broken, then why read any farther? While it’s simple, it has some drawbacks.

It’s only a short-term picture – If you spent a lot of money on a lucrative project that won’t pay off for a few months, your bank account is going to paint the picture of someone who’s not in the best financial health. We both know the reality of the situation, but the numbers aren’t so favorable.

Growth means change, especially for your accountants – If your current sales are less than $25 million, you have the luxury of choosing which way to execute your books. But once you hit that $25 million level, you’re required to conform to GAAP (generally accepted accounting principles), and that means it’s time for accrual accounting. Running with the big dogs means you need to do your accounting like … bigger dogs? You see what we mean.

Accrual Accounting

Everything is recorded when it’s billed or earned – Remember that big project we just mentioned? The one where you laid out a bunch of cash to get started? Under accrual accounting, the revenue from that project goes on the books when you got started. The same thing applies to your expenses. If you bought a new computer but you aren’t going to mail the check 30 days, the cost of that computer goes on your expenses the day you brought it home.

So why is this so great? It’s a more accurate view of what’s going on in your business. Your ledgers show that you’ve got a big project on the books, and even though you spent some cash to get going, the whole picture is laid out right there and it’s a pretty accurate view of what’s going on. You spent a little money to make a lot of money, and even though you’ve got some bills coming due, you’re in a good spot. 

Then why isn’t everyone doing this? There are really two factors that scare people off from accrual accounting. The first is that it takes a bit more work to crunch the numbers. You’re recording the actual ins-and-outs of cash alongside other payments that have yet to happen. There’s a bit more heavy lifting, but once you get that done, the results are pretty neat. The biggest reason people don’t switch is the transition period. When you go from cash to accrual accounting, there’s a natural sort of hunkering-down where you and your accountant have to lock yourselves in a room with a whole lot of paperwork and make the switch. But if you’re thinking about doing it, just make a plan to do it at a specified point in the future, work on keeping solid records, and when the time comes, you’ll be prepared for a neat and (relatively) painless transition. 

See? That wasn’t so bad.

What’s the next growth step that your organization needs to take? Call Core Group US and talk to one of our advisors and we can help you find your way there.