Cash v Accrual Accounting – Which one is the Best Option for Your Small Business?
June 6th, 2022
Field service businesses can choose cash or accrual accounting systems depending on their needs and goals. Both these accounting methods offer specific advantages as well as limitations. Let's guide you through the key differences between these foundational accounting concepts and see which one is the best option for you.
What is Cash Accounting?
Cash accounting is an accounting method that records transactions when they are completed in cash terms. In cash accounting, a business will record income when cash is received and an expense is recorded when cash is paid. It does not account for credit sales or purchases. Thus, businesses would only record a transaction if it involves cash. Therefore, cash accounting has no use for accruals and deferrals. It only records a transaction when cash exchanges hands.
What is Accrual Accounting?
Accrual accounting is an accounting method that records financial transactions as and when they happen. In accrual accounting, a business will record income when it is earned and record an expense when it is incurred. It means recording a transaction under accrual accounting does not require receiving or paying cash. Therefore, it will record accruals and deferrals as well. Accounts receivable and accounts payable then become the key factors when maintaining accounting records under the accrual accounting system.
Pros and Cons of Using Cash Accounting
Cash accounting is widely used by small businesses around the world for its simplicity and accuracy. Let's evaluate the pros and cons of using cash accounting for your field service business.
Simple and Easy method
You do not need to record a transaction until you receive or pay cash. It does not complicate accounting records and follows a simple and easy routine.
Small business owners can manage their account books using cash accounting themselves. They do not need to hire specialist accountants when using cash accounting.
Cash accounting saves you tax expenses as well. Unlike accrual accounting, it does not boost your revenue immediately. Therefore, you only pay taxes on income received in your bank account.
No GAAP Compliance
Cash accounting does not follow the Generally Accepted Accounting Principles (GAAP). Therefore, if it’s a statutory requirement for your business, you cannot adopt cash accounting.
Businesses often receive revenue in parts and also do not pay upfront for all kinds of expenses. Using cash accounting does not depict accurate profits if the business involves deferred financial payments and receipts.
Not Suitable for Credit Sales
Cash accounting does not encourage credit sales. Small business owners tend to ignore credit sales when they follow cash accounting principles for a long time.
Who Should Use Cash Accounting?
Considering GAAP compliance, cash accounting can be used by small and medium-sized businesses with a turnover of less than $25 million annually. Field service businesses are likely to fall under this category. For its simplicity and cost-effectiveness, it is a useful accounting method for small businesses. Also, you should consider your accounting literacy as a small business owner. Automating accounting tasks through reliable software is an ideal option for you when following cash accounting.
Pros and Cons of Accrual Accounting
Large and listed companies must follow accrual accounting for regulatory compliance. It is mandatory for all listed companies and large businesses above the $25 million revenue threshold. Let’s discuss the pros and cons of using accrual accounting.
Accurate Financial Projection
Accrual accounting records all types of financial transactions. It records the revenue when it is earned and expenses when they are committed. Therefore, it presents an accurate financial projection of your business at any time.
Unlike cash accounting, you can scale the accrual accounting system as your business grows. Accrual accounting methods are suitable for businesses of all sizes.
Accrual accounting follows GAAP compliance. So, if it is a compliance requirement for your small field service business, you should opt for accrual accounting.
You'll need more resources to deploy accrual accounting than cash accounting. You'll need to monitor cash flows as well as accounts receivable and payables separately. Requires Specific Skills Managing accrual accounting requires special accounting skills. You may need to hire an accountant or use accounting software to maintain accrual accounting records.
Who Should Use Accrual Accounting?
Accrual accounting is mandatory for businesses with more than $25 million in revenue. Also, if it is a regulatory requirement to follow GAAP rules, you should opt for accrual accounting. Every small business plans to grow and scale as they progress. If you are running a field service business, you’re likely to scale your business in the coming years. Therefore, choose the accrual accounting system when planning for the long term. You'll keep accurate and detailed accounting records through accrual accounting as well.
Cash and accrual accounting systems are in use by small businesses alike. Cash accounting is favored by small businesses with limited accounting requirements. You should opt for cash accounting if you are looking for simplicity and cost-effectiveness. Accrual accounting is the most widely used accounting method. Once you adopt it, you do not need to change to cash accounting in the future with growth. Therefore, you should opt for accrual accounting if you are looking for a scalable and compliant accounting system.