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Should You Use Cash or Accrual Accounting?

 
 

The choice of your business’s accounting method from the start shouldn’t be taken lightly. Whether you use a cash basis or accrual basis of accounting – can have a long-term impact on your profit/loss data, your tax strategy, and even your ability to secure financing or attract investment. Each method has its own benefits and drawbacks, making it better for some businesses than others. Even if you rely on an outside bookkeeper, understanding how these methods differ can help you be sure you’re using the right one.

 

Timing Is Everything

The essential difference between cash and accrual accounting is when income and expenses are recorded:

  • Cash: Businesses that use the cash basis record income and expenses on the day funds are paid or received. For example, if you invoice a customer for $1,000 on June 1, and your customer pays you on June 10, you would record this payable on June 10 – when the cash is in hand.
  • Accrual: The accrual basis recognizes each item on the day it becomes payable or receivable. Using the accrual basis, that $1,000 would be recorded on June 1 – the invoice date – instead of June 10 – the actual payment date.

 

Impact on Accounting

The appeal of cash accounting is its simplicity: The figures on a business’s balance sheet are consistent with its bank balance. Unfortunately, cash accounting fails to capture the long-term complexity of payables and receivables, and its quarterly or annual figures may present a distorted view of your performance. While more complex, accrual accounting can provide a better picture of your performance by including factors such as long-term projects, accounts payable and receivable, and prepaid or accrued expenses.

 

Impact on Your Balance Sheet

For businesses that use the cash basis, one major downside is its tendency to show large profit fluctuations from one period to the next. While this may not be the case for a restaurant or retail store, it could pose a problem for businesses like construction companies that perform long-term projects. Inconsistent profit data can make it harder to gauge your year-over-year performance or demonstrate your profitability to prospective lenders or investors. But one upside of cash accounting is the ability to defer income and accelerate deductions – which can help some businesses at the end of the tax year.

 

Optimizing Cash Management

Whether you choose the cash basis or accrual basis of accounting may depend on the size of your business, transaction volume, and IRS rules. If you’re in doubt, an accountant or tax professional can help you find the best way to record your payables and receivables.

 

Whichever method you choose, having the right banking tools is key. At Sun National Bank, we offer a wide array of services and technologies designed to bring greater control, efficiency, and insight to your business’s payables and receivables. Learn more about our many cash management solutions today.


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