What Is Petty Cash and How Does It Work?
Business expenses aren't always exorbitant. Sometimes, businesses must spend a few bucks to buy a treat for a client, replenish their paper supply, or purchase a parking pass. For businesses without a cash register, this is where petty cash comes into the picture. Businesses of all sizes use petty cash to fulfill minute and unexpected business expenses.
In this blog post, we'll discuss petty cash and why and important part of your accounting processes. Keep reading to learn more!
What Is Petty Cash?
Petty cash is a small financial reserve, used to purchase small and unexpected items for business operations. According to Investopedia, it often does not exceed a hundred dollars. This cash is generally kept in a secure, locked drawer or box accessible only by the designated custodian or bookkeeper. Traditionally, petty cash is actual money. Nowadays, businesses also use digital money.
Companies often use petty cash to purchase coffee, office supplies, parking, snacks, postage, and other unpredictable small expenses, which are often too minor for credit cards and checks. Your petty cash fund should be tracked and updated regularly to prevent theft or overspending. As you would with your business's more significant finances, you'll want to keep accurate records of where the money is coming from and going.
How do Businesses Use Petty Cash?
Convenience and accessibility are the top reasons companies create a petty cash stash. It's often inconvenient for companies to reimburse or write off small expenses, and this can cause delays in the payment process. Petty cash helps businesses keep their operations running without any hiccups.
Petty cash also creates transparency and accountability when it comes to business spending. It allows companies to have better control over their funds with accurate tracking of transactions, even at a minor scale. Additionally, using petty cash reduces costs associated with traditional payment methods, such as bank fees and check-writing charges. Despite these advantages, petty cash also presents several disadvantages:
Security risk: Petty cash faces similar weaknesses related to solid financial security as cash. It can be prone to theft and fraud if the funds are not adequately monitored and managed.
Reliability risk: If you don't assign the right person to handle the petty cash, there is a risk that it might not be used efficiently. Inaccurate records pose a risk of fraud and overspending.
Outdated: Petty cash can be antiquated in today's digital world. In some cases, maintaining and managing a petty cash box could take time and effort. Moreover, digital documentation is more reliable and convenient than paper records.
Petty cash should not be used for employee reimbursements. These should be handled using either company debit cards or when unable using payroll to repay employee expenses incurred for the business
Petty Cash vs. Cash on Hand
Cash on hand refers to the cash a business has in its till at any given time. This money is used to make changes for customers, purchase office supplies, and pay employees owed wages. Since petty cash is a company's financial resource, it's included in the cash on hand. On the other hand, petty cash is usually kept with a designated custodian or bookkeeper as they are held responsible for keeping accurate records of all transactions made from the fund.
Petty cash shouldn't be confused with emergency funds, either. While companies should have the latter in case of unexpected minor expenses, it is typically kept in a separate bank account rather than stored as physical or digital money. Since cash on hand is primarily liquid, using them for emergencies is inconvenient and is reserved for more significant transactions.
Management Tips for Petty Cash
To ensure that your company's money is being used effectively and efficiently, here are some management tips you should consider:
Regularly replenish your stash: Incidental expenses occur daily and sporadically. It's not until you run out of petty cash funds that you realize you don't have money to spare. To prevent this, you should schedule a specific day in a month or set up an auto-deposit to ensure you always have funds available.
Establish a spending limit: Petty cash should be used only for small, unexpected expenses. To prevent yourself or your employees from misusing the funds, establish a spending limit to ensure that you are not overspending unnecessarily.
Create rules regarding the use of petty cash: Create written petty cash policies. In relation to the point above, another way to mitigate petty cash misuse is to establish rules on how employees can use them. For example, you can determine what qualifies as eligible petty cash purchases and requiring petty cash receipts.
Closely monitor expenditures: Petty cash funds are vulnerable to misuse, and conducting regular audits will help you stay on top of any suspicious activity. Tracking the spending habits of your employees also helps create a culture of transparency and accountability, which is beneficial for all parties involved.
Appoint a reliable keeper: A petty cash custodian, sometimes called a Petty Cash Cashier, is responsible for keeping track of your petty cash records. When appointing someone to this role, look for someone who is organized, trustworthy, and capable of following through with their duties.
Bookkeeping: In order to ensure accurate financial statements, make sure that you are recording your petty cash log and petty cash balances via journal entries in your accounting software. Reconcile the petty cash account at least monthly and replenish the funds to the original balance from your business bank as necessary.
Petty Cash and Taxes
Petty cash expenses are business expenses — you'll most likely deduct them from your end-of-the-year taxes. However, you must keep records of all petty cash transactions to prove it was spent for business purposes. You'll need these records when filing taxes or if the IRS audits your business.
According to IRS Publication 583, businesses must record all cash payments, regardless of the amount. For example, if you pay an employee $10 in cash for lunch, you'll need to keep track of it for tax purposes. The overall amount of petty cash and other expenses should also be reported as the company's overall expenses.
Conclusion
In conclusion, businesses use petty cash funds for a variety of reasons, including convenience, flexibility, and the ability to quickly handle small expenses. While it may seem insignificant, petty cash plays a crucial role in keeping businesses running smoothly. So next time you're wondering why there's a jar of cash on the office desk, remember that it's all part of a smart financial strategy. Every penny counts!