Small Business Series: 4 Reasons to Use Cash Basis Accounting
As a business owner, one of the most important decisions you will make is how to handle your accounting. While there are several methods available, two of the most common are cash basis accounting and accrual accounting.
Let’s explore four benefits of using cash basis accounting over accrual accounting for your business.
Simplicity One of the primary advantages of cash basis accounting is its simplicity. Unlike accrual accounting, which requires tracking accounts receivable and accounts payable, cash basis accounting only requires you to record transactions when cash is received or paid out. This makes it easier to understand and less time-consuming to implement. For small business owners who don't have a lot of accounting experience, cash basis accounting can be an attractive option.
Improved Cash Flow Management Cash basis accounting allows business owners to have a more accurate picture of their cash flow situation. This is because cash basis accounting records transactions when money actually changes hands, rather than when revenue is earned or expenses are incurred. This makes it easier to track the actual inflow and outflow of cash, which can be a major advantage for businesses with tight cash flow situations.
Lower Tax Liability Using cash basis accounting can also result in a lower tax liability for some businesses. This is because income is only recognized when cash is received, and expenses are only recognized when they are paid. This means that businesses can defer or accelerate payments to manage their tax liability. For example, a business owner may choose to delay invoicing a client until the following year to defer income, or they may pay vendors early to accelerate expenses. This flexibility can be particularly helpful for businesses with fluctuating income or expenses.
Reduced Record-Keeping Requirements Cash basis accounting requires less record-keeping than accrual accounting. This is because it only requires tracking cash inflows and outflows, rather than recording transactions based on complex rules and principles. For small businesses with limited staff or resources, this can be a significant advantage. By reducing the time and resources required for accounting, business owners can focus on other important aspects of their business, such as sales and marketing.
Cash basis accounting can offer several advantages for business owners over accrual accounting. It is simpler, provides a more accurate picture of cash flow, can result in lower tax liabilities, and requires less record-keeping. While there are some limitations to cash basis accounting, such as its inability to provide an accurate picture of a business's financial performance over time, and some legal reasons for under which circumstances cash basis accounting can not be used, it can be an effective option for many small businesses. As with any accounting method, it's important to weigh the benefits and drawbacks, discuss with your CPA, and choose the one that is best for your specific business needs.
