The Advantages and Disadvantages of Accrual and Cash Basis Accounting

Many probably don’t know that there are two main types of accounting. Indeed, many probably don’t even know what an accountant does. As a small business owner, you either hire someone on a temporary basis to do your books, or you do your own books with the help of automated software.

At Peter B. Scala, CPA we want you to hire us to do your books. Why? Because there are accounting techniques you won’t know about otherwise. We can do what other so-called experts might ignore. We take pride in our relationships with clients because, in the end, accountants can save business owners money in the long run. 

Accrual or Cash

One aspect of accounting we pay close attention to is the difference between accrual-based accounting and cash-based accounting. If one works better over the other for our clients, we’re there to answer any questions. Your business is your livelihood. You deserve reputable accounting services that work for you.

In the simplest of definitions, accrual-based accounting means all expenses and revenue is recorded and used as they occur. With cash-based accounting, expenses and revenue aren’t addressed until the cash exchange occurs. Most of the business world uses accrual-based accounting.

Of course, there are times when one works better than the other. The following list of advantages and disadvantages should help define when to use both accounting methods.

Advantages and Disadvantages of Cash-Based Accounting

It might not be immediately obvious, but most of us understand cash-based accounting without knowing it. We go to the supermarket, buy things, then leave. If you pay with cash or with a debit card, you fall into the cash-based group. If you buy stuff with a credit card, you’re in the accrual group.

• Advantages—Cash-based accounting is the simplest. You add the money to the records when it comes in. When you need expenses, the money is taken out of the business right then. Most of us do this every month when we pay our bills. If you run a business, cash flow can be an issue if not managed properly. 

Adding and subtracting the cash numbers is straightforward, so there is no need to complicate the record ledgers with tracked accounts payables and receivables. Perhaps the biggest advantage is always knowing exactly where you stand financially.

• Disadvantages—The simplicity of the cash-based accounting method is also its downfall. The simple adding and subtracting only gives a view of a business at that point in time. Of course, we all know that a business has more depth than taking financial snapshots could reveal.

If you run a business and have several thousand dollars of unpaid invoices, they won’t show up in the cash-based accounting method until they are paid. Yet, you know the invoices will be paid but can’t record the revenue until invoices are paid.

However, if the invoices are paid and recorded the following month, it seems as if the recorded-setting month didn’t happen until the next month. As you diversify and consider other product lines or services, you might need capital and investment. Cash-based accounting records don’t tell investors accurate trends. 

Advantages and Disadvantages of Accrual-Based Accounting

Primarily because of the disadvantages listed above, the accrual-based accounting method is the most commonly used in the business world. This is particularly true now as the world adjusts to buying things online and having the items delivered. Nonetheless, we can still flesh out some advantages and disadvantages.

• Advantages—Accrual-based accounting recognizes expenses as revenue as they incur, not as they are paid. This accounting method seems to place more emphasis on doing the work rather than paying for the work. This way the economy doesn’t collapse because a handful of companies didn’t pay their bills. This method relies on things like bankruptcy so that the business world keeps moving forward.

Accrual-based accounting gives people a better view of your long-term outlook. Because things keep moving forward, trends develop, and investors start seeing opportunities. An accountant skilled at keeping accurate accrual-based records can be a lifesaver for small business owners who often operate on the fringes. 

• Disadvantages—Accrual-based accounting is complicated and takes an expert to fully utilize all the benefits. This is a disadvantage to small business owners who usually don’t have the money to pay for accredited accounting services. The small business owner would need to actively monitor the financial records, including accounts payables, cash flow, and accounts receivables.

Another disadvantage (primarily for a small business) is the business has a hard time understanding the financial situation at a specific moment in time. If you made $10,000 in a month but all invoices won’t be paid until next month, you’ve worked without getting paid for that time. Some businesses don’t have the time or financial resources to do that.  

It’s worth noting that if your business has $25 million or more in annual revenue, you must use accrual-based accounting that follows GAAP, or, Generally Accepted Accounting Principles. GAAP comes into play because of the Sarbanes/Oxley Act and the criminal handling of Enron’s financial records.

This might seem like a high bar considering the hundreds of thousands of small to medium-sized businesses that dot the American landscape. Then again, most cannot afford to hire a full-time CPA. This is where we come in. At Peter B. Scala, CPA we put your reputation first. 

Conclusion

Accrual-based accounting has emerged as the financial records engine of the 21^st century. At Peter B. Scala, CPA we know all the advantages and disadvantages of both accounting methods. Hiring us means you sign onto a promise that you’ll receive service from experts following accurate and transparent accounting practices. 

From expanding your business to paying your business taxes, Peter B. Scala, CPA has the expertise you need to run your small to medium-sized business. Our work culture lives and breathes practices like GAAP. As certified public accountants, we take our responsibilities to heart and value ethics for everything we do.