For small businesses to thrive, it’s important to always keep an accurate account of all company-related expenditures. Not only does it keep your business afloat, but it’s also an essential step towards growth and development.
However, while accounting is a necessity, not everyone loves to deal with it – which is pretty understandable. Some business owners prefer managing their business more than having to go through accounting. But never fear, as accounting isn’t as complicated as it may seem. All it takes is knowing the right procedure to follow.
When it comes to accounting, there are two methods that you’ll need to know: accrual basis accounting and cash basis accounting. Even if you have an in-house accounting who’s doing all the accounting work for you, it still pays to know and understand how each method works. That way, you’ll be able to select the best bookkeeping practice that suits your business’s needs.
In this article, we will discuss accrual accounting and cash accounting to determine which one is the better option for you. First, let’s define each of the two accounting methods.
What is Accrual Accounting?
Accrual accounting is a type of accounting method that’s usually used if your company follows the accounting standards outlined by the GAAP (generally accepted accounting principles). Through the use of this accrual accounting, you’ll get a clearer overview of your company’s overall financial state.
Using the accrual method for accounting, a company’s income and expenditures are recorded whenever they are billed, regardless of when and how the payment will be received. For example, if your small business bills $1,500 in income on April 1, you would record that same amount as income in April’s bookkeeping – even if you received the funds on a much later date (e.g., May 20).
The same goes for your expenses. For instance, if your small law office purchases paper and stationery supplies on a credit in July, but doesn’t pay the bill until August, you would still record that transaction as an expenditure for July.
Benefits of Accrual Accounting
Accrual accounting provides a more comprehensive and long-term overview of how your company is doing financially. This type of accounting method provides an accurate presentation of the amount of money your company has earned and spent within a particular period. It also gives you an idea of when your company should consider speeding up or slowing down over the course of a quarter or a full year.
In addition, accrual accounting also follows the nationally recognized and accepted standards of business accounting. That means if your business were to grow, its accounting method would not need any significant changes. Apart from that, here are other benefits that accrual accounting can provide:
Clearer and More Accurate Financial Outlook
While accrual accounting is a bit more complex than cash accounting, it does give small business owners a better and more realistic idea of the state of their income and expenses during a given period. The information that you get from this type of accounting method is valuable as it gives you a clearer and more accurate outlook of your financial status at any point of the year. It also gives you a better understanding of consumer spending habits, which would allow you to make the necessary adjustments and plan better for potential peak months of your business operations.
Follows Standard GAAP Rules
Another notable benefit of accrual accounting is that it strictly follows the Generally Accepted Accounting Principles (GAAP). This level of comprehensiveness makes it an absolute necessity for companies with more than $25 million annual income.
We know what you’re thinking, and yes – $25 million in sales and revenue may seem very high for the majority of small businesses. That’s why in most cases, you’ll only be using accrual accounting if your bank requires it.
Downsides of Accrual Accounting
Accrual accounting has a lot of positives to showcase. However, it also has its share of drawbacks that you also need to know. The most notable of these disadvantages is the complex procedure. It also displays high inaccuracies of a company’s short-term financial situation. Apart from that, there are other disadvantages that you’ll find in accrual accounting:
It’s More Resources-intensive Option
Accrual accounting comes with complexity and more paperwork to your financial reporting process, which makes it more expensive to implement for most small businesses. Since you’ll record revenue before they even receive the money, cash flow has to be tracked in a separate manner to make sure your company can cover the monthly bills.
Inaccurate Short-Term Financial Overview
While it does provide a better long-term view of your company’s finances, accrual accounting provides an abysmal short-term financial overview. The cash method, which we will discuss in the next section, gives you a much better picture of the funds inside your bank account. The reason for this inaccuracy is because it also takes into account money that is yet to come into your bank account.
Because of this, accrual accounting can be a devastating option financially for small business owners. For instance, your bookkeeping could show a large amount of revenue when your bank account has zero balance.
What is Cash Accounting?
Cash accounting is a simple and more applicable accounting method for small businesses. In its most basic description, cash accounting records income as it’s received and expenses as they are paid. You don’t need to make ghost recordings of cash that are not yet there like what the accrual method does.
For example, if you invoice a client for $1,500 on April 1 and receive payment on May 15, you will record the income as money received for May. So, the general rule is that you’ll only record income when you actually receive the payment and it’s already available in your bank account.
It’s also important to note that the cash method doesn’t take into account your account receivables and payable. The reason for this is that it only applies to payments from your clients when payment is received. So, whether it’s in the form of on-hand cash, credit card receipts, or checks, cash accounting only works once your client settles their account and pays you whatever method they find convenient.
Similarly, cash accounting will only record your expenses whenever money leaves your account to pay expenses to vendors, suppliers, and other third-party goods or service providers. So, if you run a law office that purchased the paper and stationery supplies via credit in July, but didn’t’ actually pay the bill until August, you would record those purchased supplied as an expense made in August.
If your small business makes less than $25 million a year and it also doesn’t sell merchandise directly to customers, cash accounting is the ideal accounting option. In fact, it’s usually the most used method of accosting for most small businesses, such as partnerships or sole proprietorships.
Benefits of Cash Accounting
The cash accounting method has a lot of benefits to offer small- to medium-sized businesses. The most notable perk is the ease of use and much-improved cash flow capability. Apart from that, there are other perks that cash accounting brings to the table:
A Simplified Accounting Process
Many small businesses prefer the cash method for its simplicity and straightforwardness. Its simplicity is comparable to that of an average person tracking their personal finances. Since you won’t be recording your accounting payables and receivables, using the cash method also makes tracking money easier as it moves in and out of your bank account.
For small businesses that operate primarily through cash transactions while not maintaining large product inventories, the cash accounting method can be of great convenience. It’s a reliable way to keep track of your revenue and expenses without needed to deal with complicated bookkeeping.
Better Income Taxes
When it comes to dealing with your taxes, cash accounting is an advantage in this area. With cash accounting, you won’t have to pay taxes on funds that you haven’t earned yet. For instance, if you invoice your customer for $1,500 in September and don’t get paid until January, you won’t have to pay taxes on that income until January of next year.
The cash method helps you save money on your taxes, as well as improving overall cash flow. It ensures that your small business will have the funds available for tax payment whenever you need to settle your annual tax income return. For even small businesses, cash accounting can be crucial to keeping your business open, especially when cash flow is scarce.
Downsides of Cash Accounting
While the cash method is the simpler and more ideal option for small business accounting, it’s not free from its share of drawbacks. With that said, here are some notable disadvantages of cash accounting:
Inaccurate Financial Picture
Since it doesn’t take into account all incoming revenue or outgoing expenses, the cash accounting method can leave you to believe that you’re having a high cash-flow month when, in fact, it’s only a result of a previous month’s supposed income.
No Records on Your Accounts Receivable or Payable
Since the method is so straightforward, it doesn’t require your bookkeeper or accounting to keep track of the actual dates that correspond to specific purchases or sales. That means there are no records of accounting payable or accounts receivable, which can potentially create challenges when your company doesn’t receive immediate payment or has outstanding bills to settle.
Doesn’t Conform to GAAP
At this point, you may already know that the cash accounting method is the direct opposite of the accrual accounting method. So, while the latter does follow the Generally Accepted Accounting Principle, the former doesn’t. That means if your business were to grow larger than $25 million in annual sales, you would need to transition your accounting process from cash accounting to accrual accounting.
Which is the Right One for Your Business?
Accrual and cash accounting are completely different from each other. However, choosing the right one will depend on the financial status of your business. The rule is simple, if your small business is earning less than $25 million per year, you should opt for the simple cash accosting method. However, if it goes above that threshold, you should opt or transition towards the more complicated yet comprehensive accrual accounting method.
Why You Should Consider Recurring Billing
Whatever accounting method you choose, it’s important to make sure that the cash keeps flowing consistently. That’s why you also need to select the ideal billing method for your business. With recurring billing, you can make sure that there will always be money coming to your business every month. Continue reading this section to discover what this billing model has to offer.
What is Recurring Billing?
Recurring billing is a form of payment that allows you to purchase products and services regularly. It’s also referred to as subscription payments or automated invoicing because it automatically charges your card every billing cycle. Subscription businesses vary in size from small mom-and-pop shops to multi-billion dollar corporations that have chosen recurring billing as their primary payment method.
Recurring Payments for Your Business
The advantages of recurring billing to businesses are clear: automated invoices mean more reliable cash flow, less work reconciling customer accounts every month, and the ability to set up automated rules that determine how much customers pay depending on what stage they’re at with their service (initiation, past due/late fees, etc.).
Recurring Payments for Your Customers
For customers, there’s the convenience of not having to open and act on invoices every month. Using recurring billing software means you can set up rules like automated payment plans with no hidden costs or fees. For example, you can set up a recurring payment to pay off your cell phone bill in installments, or you could split the cost of an annual software subscription into monthly payments.
Recurring Payments for Both
For both business owners and customers, recurring billing offers more than just convenience; it saves time and money. When businesses use automated invoicing like recurring billing, they eliminate the costs and inefficiencies of manual payment processing. Customers save time and money by not having to open and act on their invoices every month; plus, automated recurring payments can be set up with no hidden fees or surprises.
Introducing Recurring Billing to Customers
Offering subscriptions on recurring payments is not always as simple as it sounds. Many companies are wary about the impact of contracts that last for years or even decades, fearing they will lose customers if something goes wrong with their service or product during that time period. But by offering your products and services through a recurring billing model, you can give your customers the convenience and peace of mind they deserve.
Recurring Payment Options for Customers: Fast, Easy Setup
To provide recurring billing options to your customers, you need a recurring payment solution that is simple and easy to use. The ReliaBills invoicing and recurring billing platform allows you to set up subscriptions in no time so that both your business and customers will start benefiting from recurring payments.
Recurring Billing for Businesses: Flexible Payment Cycles
One of the biggest advantages of offering subscriptions on a recurring basis is steady cash flow and reduced administrative costs, which allow you to scale your business more easily as it grows. A flexible payment cycle also means billing changes are less likely to cause errors or payment delays.
Recurring Billing Increases Customer Lifetime Value
A recurring billing model can increase your customer lifetime value because it allows you to charge customers more over the course of their membership. This level of convenience will also decrease churn rate, which is one of the most important metrics for subscription-based businesses to measure success.
Recurring Payment Options Allow for Hassle-Free, Automated Invoices
Customers no longer need to manually open or act on their invoices every month because recurring billing software automatically sends out invoices and handles payments. Recurring bills also allow you to process refunds more easily so that customers can get what they paid for without the hassle.
Recurring Payments Mean Better Customer Service for Your Customers
To benefit from the advantages of recurring billing, you need a payment solution that allows your customers to manage their subscriptions online easily and proactively communicate with customer support if they have any issues along the way. This ensures better service for them while also building trust between your company and its customers.
With recurring billing on your side, you can provide customers with the convenience and peace of mind they deserve while also building a successful business that scales as it grows.
Get ReliaBills today and start offering subscriptions on a recurring basis! That way, your business can benefit from steadier cash flow, reduced administrative costs, increased customer lifetime value, automated invoicing, and hassle-free transactions. Create your free account now and upgrade it to ReliaBills PLUS to get the total package!
At the end of the day, it’s important to know when you’ll need a specific accounting method for your business. If you’re just starting, cash accounting is the go-to option. But if you’ve grown your business to a point where you’re earning $25 million or more, it’s time to transition to accrual accounting. If you want to learn how ReliaBills works, feel free to browse at https://www.reliabills.com/.