Is Cash Basis Record Keeping/Accounting Sufficient?
Recently I joined the age-old debate on X (FKA Twitter) about Cash vs Accrual and which type makes sense:
Here is my official “hot take” on the subject:
Cash basis record keeping is not sufficient to understand long term profitability in the day-to-day management of your business.
Where cash basis accounting and record keeping is great for income tax purposes, it falls short as it pertains to management and internal reporting.
This is because it doesn’t give you the information you need to run your business. What is the biggest thing that you need to run your business, you ask?
But first, let’s take a step back, and explain more about cash versus accrual accounting.
What is Cash Basis Accounting?
Cash basis accounting is posting your inflows and outflows; your revenues and expenses, only at the time they are paid out or received.
What is Accrual Based Accounting?
Accrual based accounting is what you should be using. It is when you post revenues when you invoice a customer, (not necessarily when you get paid), and expenses when you have a bill to be paid (not necessarily when you pay it). When you do that, you’re able to post your revenues and expenses and costs in terms of when they were either earned, or incurred on a month-over-month basis. This allows you to compare those months much better. And there’s less “wavy” ups and downs.
An Example of Each Type In Action
You have rent of $20,000 a month, and you haven’t paid rent in three months. $20,000 times three is $60,000. When you pay the rent owed of $60,000 in month three, that expense on a cash basis hits your books, one month at $60,000 in month three. That’s cash basis accounting-and a big swing in expenses on month three.
On accrual basis accounting, you have three bills of $20,000 for each month, so the expenses each month are $20,000 versus $60,000. This same concept applies to your invoices or revenues. You invoice your customers $100,000 over three months, but you don’t receive any money until month three: $100,000 all at once. You get $100,000 of revenue in month three, but you would record this across each month; $30,000, $40,000, $30,000, when you want to see that revenue applied month-over-month.
Cash basis accounting is not preferable from a management accounting standpoint, but it is great for tax purposes, especially if you are concerned about being taxed on income not yet received.
Accrual based accounting is much better from a management or internal reporting perspective because it shows a more accurate picture month-over-month and allows you to get a better picture of profitability long term.
You can explore more detail on this subject here:
What method do you use? Do you find one preferable over the other? Tell me your thoughts in the comments 👇
Originally published at https://www.linkedin.com.
