Accounting is part of business operations to keep track of all business transactions. Business transactions are of various natures there will be income and expenses. The income can be earned as products sold and services provided on a credit basis or it might be the case that the product and services are sold for cash. There are two main small businesses accounting strategies cash and accrual basis of accounting. Small businesses can opt for cash or accrual basis of accounting based on their business operations and the nature of the business.
Further, the income could be of primary business activity of assets revelation gain or loss or other income. Expenses also are of a different nature; they might be related to operational expenses or financing activities etc.
There are expenses such as meals and entertainment, and a recurring subscription that is paid when due this is while others might be credited initially and paid for later.
Account Payable and Account Receivable in Cash vs Accrual
So, the income and expenses are not received and paid when it's due but there might be a creditor/payable and debtor/Receivable in every business. If the business is a managing account payable and account receivable it is using an accrual basis of accounting to manage
While doing bookkeeping for your small business you can use this small business accounting strategy you can choose between two different account methods known as cash and accrual bases of accounting Accrual Basis of accounting fie small business.
On an accrual basis of accounting income is recorded when earned and expenses are recorded when incurred irrespective of whether cash is received or paid or not.
The accrual method of accounting follows the famous accounting principle called the matching principle, which states that an entity should recognize revenues and expenses in the same period. It also follows the revenue recognition principle, which states that organizations should recognize income/revenue when earned.
To match the records there might be more accounts under this method, for example, account receivable and payable.
On an accrual basis, you can manage Accounts receivable and payable for revenue and expenses that are not yet received or paid. You can create an Invoice or bill to track these incomes and expenses.
When business operation expands it becomes the need of your small business to use an accrual method of accounting. It shows the income and expenses detail correctly and as per the statutory obligation and it shows the correct picture of your assets and liabilities to date.
Advantages of accrual basis of accounting for small business
The accrual basis of accounting represents a clear picture of business assets and liabilities. This is one of the reasons this is the preferred accounting method. Small businesses and new startups must use an accrual basis of accounting because investors usually prefer the accrual basis of accounting because of its clarity. Cash Basis of accounting for small business on a cash basis of accounting you can only record when income in cash is received and expenses are paid.
Advantages of cash basis of accounting or cash accounting
1. Few accounts: When you adopt a cash basis of accounting you have to recognize income when received and expenses when paid there will be two accounts involved cash/bank will be debited and credited and income will be credited and expenses debited there are no other accounts such as keeping a record of creditor and debtor or account payable and receivables so there are fewer accounts and less complexity.
2. Easy to understand: by debiting and crediting the cash account and respective income and expense account one will easily understand and do it.
3. Takes less time
Disadvantages of cash basis of accounting
The disadvantage of cash-basis accounting is that it doesn’t provide all the information about income and expenses. The cash basis of accounting doesn’t show future payments and receipts, so it understates the assets and liabilities of the entity. Limited use Not all businesses can opt to use cash-basis accounting. The entity having credit sales and purchases can’t use the cash accounting method:
· Sell products or services on a credit
· Have gross receipts higher than the IRS requirements
· Need inventory management
Disadvantages of Accrual Accounting
Accrual accounting is typically seen as more time-consuming and difficult to understand compared to cash accounting. Additionally, accrual accounting can skew the financial performance of the company. Consider if you made the sale and haven't yet received payment for that this will show the sale has been made and cash and bank have not been debited yet.
Organizations have a very limited role choice in choosing between accrual and cash accounting. Cash accounting is likely to be the preferred method for small entities. GAAP-compliant entities are required to use accrual accounting. IFRS and GAAP roles state that mid and large-size entities must follow the accrual basis of accounting.
So that the stakeholder and the user of the financial report or financial statement get the full picture of the company's complete assets and liabilities. The investor is external users who usually prefer an accrual basis of accounting. So, to avoid any inconvenience and probable shifting of small entities we must use an accrual basis of accounting.
The best strategy for small businesses is to adopt an accrual basis of accounting
Also, when an organization grows larger it has business operations not only in cash but on credit as well and is bound by GAAP and IFRS to use the accrual basis of accounting. It is a better strategy for small businesses to adopt an accrual basis of accounting at the early stages of their business to remain up to the laws and IFRS and GAAP regulations and have a clear understanding of business finances. Also, this small business accounting strategy will help you avoid the future hassle of shifting and adapting to the accrual basis of accounting from the cash basis of accounting.
Bookkeeping Basics for Small Business Owners
What is a Chart of Accounts? How to Set a Chart of Accounts?
6 Small Business Bookkeeping Fundamentals You Can't Ignore