What is Cash Basis?

The cash basis method is pretty simple. In this system, you record money only when it actually changes hands. This means that you record income when you receive it, and you record expenses when you pay them. For example, if you sell something today and the customer pays you right away, you would record that income on the same day. Similarly, if you buy supplies today and pay for them immediately, you would record that expense today as well.

This method is easy to understand and is often used by small businesses or people just starting out because it matches how money comes in and out of the business. If you’re a small shop or a freelancer, cash basis bookkeeping can help you see exactly how much money you have at any given time. You don’t have to worry about complicated tracking, and it helps you keep things simple.

What is Accrual Basis?

The accrual basis method is a little more complex, but it gives you a bigger picture of your business’s financial health. With accrual accounting, you record income when you earn it, and you record expenses when you incur them, even if you haven’t actually received or paid the money yet. For example, if you sell a product today but your customer doesn’t pay until next month, you would still record the income today, because that’s when the sale happened. Similarly, if you buy something today but don’t pay the supplier until next month, you would record the expense today, because that’s when you made the purchase.

The accrual method gives a more complete view of your business’s financial situation, especially if you are working with customers or suppliers on credit. It helps you track money you’re owed and money you still need to pay, even if the cash hasn’t moved yet.

How Do You Choose Between Cash Basis and Accrual Basis?

Now that we know the basics of both methods, let’s talk about how to choose which one is best for your business. Here are some things to consider:

1. Size of Your Business

If you’re a small business owner, such as a local bakery, a landscaper, or a freelance writer, cash basis bookkeeping might be the easiest choice. Since you’re probably getting paid right away and paying for things on the spot, cash basis can help you keep track of your actual cash flow without worrying about future payments or bills.

However, if your business is larger, or you have many customers who buy on credit or you pay suppliers on credit, accrual basis might make more sense. Businesses like stores, larger service providers, or those that deal with inventory often choose the accrual method because it provides a better understanding of their financial standing.

2. Complexity of Your Business Transactions

If your business involves a lot of transactions where you pay for things ahead of time, or you offer credit to customers (like invoicing them and getting paid later), accrual basis might be the better choice. It helps you track money that’s coming in or going out, even if it hasn’t been paid yet. For example, if you run a business where clients pay you in monthly installments, the accrual method will help you keep track of income as it’s earned, not just when it’s paid.

On the other hand, if your business transactions are simpler, and you get paid right away and pay for things immediately, cash basis can keep things straightforward and easier to handle.

3. Tax Considerations

The method you choose can also affect your taxes. In general, cash basis accounting is easier to use for tax purposes because it directly reflects when you receive money and when you spend it. Many small businesses use this method because it’s easy and it helps them know how much money they have to pay in taxes at the end of the year.

For larger businesses, or businesses that make a lot of sales on credit, the IRS may require you to use the accrual method if your business reaches certain size limits. This is because accrual accounting provides a more accurate view of your income and expenses, which helps ensure that taxes are reported correctly.

4. Financial Reporting Needs

If you need detailed reports about your business’s financial health, such as if you’re looking for a loan or trying to attract investors, accrual accounting might be more helpful. Since it shows when income and expenses occur, even if the money hasn’t changed hands yet, it gives a clearer picture of how your business is performing over time.

However, if you only need a basic overview of your financial situation to keep track of how much money you have in your bank account, cash basis accounting might be enough. It’s simpler and gives you an easy way to track actual cash flow.

Setting up QuickBooks might be a daunting tax for the non bookkeeper.  Don’t despair you’re not alone aside from setting you up cash basis or accrual I also can help you with the chart of account and customize it to your business model.

Contact Watertight Bookkeeping and see how we can help you!