Cash vs. Accrual Accounting: What's Best for Your Business?
Cash vs. Accrual Accounting: What’s Best for Your Business?
If you’re starting a small business, choosing which accounting method to use is a major decision.
The two main methods of recording transactions – cash basis and accrual basis – can have different impacts on your bookkeeping process, your tax strategy, and even your ability to secure financing and investments. There are pros and cons to each of these accounting methods, depending on your business needs and goals. Here’s what you need to know:
Timing Is Everything
The essential difference between cash basis and accrual basis accounting is when income and expenses are recorded.
With cash-basis accounting, income is recorded when funds are received, and expenses are recorded when funds are paid.
Example: On September 2, you invoice a customer for $5,000 of merchandise and get a utility bill in the mail for $500. Your customer pays you on September 14 and you mail a check to the utility company on September 29. You record these transactions on September 14 and September 29, respectively.
With accrual accounting, income is recorded when it is earned, and expenses are recorded when they are incurred. So, in the above scenario, you would record both transactions on September 2 – the date that you invoice the customer and receive the utility bill.
Cash: Keep It Simple
The main advantage of the cash basis is its simplicity.
The figures on your balance sheet stay consistent with your bank balance, so it’s easy to track your cash flow, and no complex accounting is needed. That’s why the cash basis is widely used by smaller businesses (per IRS rules, it’s generally only available to businesses with less than $25 million in annual sales). Not surprisingly, it’s also the method that most individuals and families use to stick to a budget.
Accrual: See the Bigger Picture
However, the cash basis can fail to accurately capture your business’s performance.
Because it’s natural for income and expenses to fluctuate throughout the year, cash accounting can appear to under- or overstate your profitability at any given time. This is especially true for construction companies, consultancies, and other small businesses that may not see regular daily income as a restaurant or retailer would.
By taking into account factors like long-range projects and prepaid expenses, accrual accounting presents a smoother, clearer picture of your enterprise’s ability to generate value. For this reason, many investors and lenders will want to see your financial documents prepared on an accrual basis.
Optimizing Your Cash Flow
Your choice between cash and accrual will depend on a number of factors, including your business size, industry, transaction volume, and any applicable IRS rules. If in doubt, an accountant or tax professional can help you make the decision that’s right for you.
Whichever accounting method you choose, having the right banking partner is key. Partnering with a community-based financial institution, such as a business-savvy credit union, can help your small business access the cash management tools it needs to streamline receivables and better control payables. Many businesses have adopted tools like ACH processing, remote deposit capture, and merchant services to simplify payments and improve cash flow.
And when it comes to moving your business forward, consider the Nu Direction Lending experience. Qualified businesses can apply in as few as 7 minutes, receive an instant preliminary offer, and secure funding in as little as a week.
The information contained herein is for general informational purposes only and does not constitute tax, legal, or business advice.
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Nu Direction Lending is a digital-first business lender that was formed and is funded by credit unions. We combine the speed and convenience of online lenders with the personalized touch of the local credit unions who help fuel our local economies.