This conversation is one that I have quite often with clients when I am presenting them reports. ‘Do you understand what cash and accrual methods are?’ Most business owners don’t but most should. Understanding these methods is what will help you to better understand your Accounting Reports and understanding your Accounting Reports helps you to better understand your business.
Cash Accounting is recognising the income and expenses in your business when they actually happen, so when you physically pay for something and physically receive the money for something, rather than on when you receive the invoice or issue an invoice. For example, if you issue an invoice on Monday but you don’t receive the payment in your account until the Thursday, you record the income against Thursday’s date in your bookkeeping.
Accrual Accounting is recognising the income and expenses when you actually issue the invoice or receive the invoice from a supplier, even though you haven’t been paid or you haven’t paid the bill. The Accrual system is what creates your debtors and creditors in your accounting software. It allows you to know what you owe and when it’s to be paid and also what is owed to you from your customers. For example, if you send an invoice on Monday, you record the sale in your books on the Monday even though you haven’t received the payment yet.
Advantages of Cash Accounting:
Cash Accounting is a simple system that tracks your businesses cash flow, for quite a few businesses that is all they are interested in doing.
If you have a small business that mostly handles cash then the Cash Accounting Method is suited to your business.
Using the Cash Accounting Method makes it easier to know at all times what is in your bank and tills
The Cash Accounting Method is used by businesses who just need their bookkeeping done to do their BAS’s and have their tax returns done.
Disadvantage of Cash Accounting:
But using the Cash Accounting Method doesn’t give you the true picture of your business. You also don’t know how much you owe or how much is owed to you.
Advantages of Accrual Accounting
Accrual Accounting is suited to businesses that don’t get paid straight away, they issue invoices on completion of their products or services and receive payment for them in the future sometime. They also purchase products and services on account with their suppliers and pay them in the future.
Accrual Accounting tracks your true financial position. It captures what money is owed to you and what money you owe to others.
If you have to deal with lots of contracts or large amounts of money, using the Accrual Accounting method will help with this.
Disadvantages of Accrual Accounting
The disadvantages of Accrual Accounting are that it is complicated and you need to have an in-depth knowledge of bookkeeping methods or have a professional undertake the work for you if you are going to use this method.
Cash, Accrual & GST
Before deciding what method you need to use, you also need to understand how each method is used when it comes to GST and lodging your BAS’s with the ATO.
If you are a Small Business with an annual turnover of less than $75,000 you do not have to register for GST or collect GST, therefore you can choose whatever accounting method you like.
If you are a Business with an annual turnover over $75,000 and under $2,000,000 you must collect and pay GST using the Cash Accounting Method. For your bookkeeping needs and for you to have a better understanding of your business you may choose to use the Accrual Accounting Method, but you must always lodge your BAS’s using the Cash Accounting Method.
If your Business has an annual turnover of over $2,000,000 then you must collect and pay GST using the Accrual Accounting Method. It is also wise to use the Accrual Accounting Method to do your bookkeeping as well as it gives you a way better understanding of your business.
Choosing what method to use
When working out what method best suits your business you need to think about what size your business is. How complicated are your business transactions and processes and whether you have the resources and knowledge to manage accrual accounting.
I would personally recommend to all business owners to use the Accrual Accounting Method, but in saying that if you are a Corner Store or other business that receives only cash all day long and you pay your suppliers as they bring you your products then there is no need to use the Accrual Accounting Method.
I would suggest that you have a talk to your accountant or bookkeeper or even feel free to firstname.lastname@example.org if you have any concerns about what method would best suite your business.