In the world of accounting, one of the first decisions a small business owner will have to make relates to the their accounting method of choice. Luckily though, there are only two choices: cash basis accounting or accrual basis accounting. Both have their benefits, both have their, let's call them, nuances. The thing is, though, unless you're an accountant, it can be tough to figure out which accounting system will be the best for you and your business.
So here's what we're going to do. We're going to break down the benefits of accrual basis accounting in straightforward, simple language to help you figure out whether or not it's the right fit for your business. (Later we'll do the same for cash basis accounting.)
Timing Matters Most
In the accrual basis accounting method, income is recognized at the moment of sale of your product or service—not when you eventually receive payment. So say you're a graphic designer. You land a project. When you begin the project, you send the client an invoice that has a specific term. Let's call it 30 days. That transaction becomes an Accounts Receivable transaction. Said differently, your business is "waiting" to receive payment.
Accrual Helps With Cash Flow Analysis
It sounds counter-intuitive, but accrual basis accounting can help you with your forward-looking cash flow analysis. With the accrual method, you're not waiting to physically receive payment for your goods of services. Instead, you know what's coming in in the near future—and that can help you plan and make smarter business decisions.
If you want to grow—like seriously grow—your business, you are likely going to have to deal with credit at some point. Loaning financial institutions tend to prefer to see accrual basis accounting. Why? It goes back to that forward-looking view we talked about. Moreover, the accrual method makes it easier to track credit you owe as well as what's owed to you.
So Who Should Use the Accrual Accounting Method?
The short answer? Most business. The long answer? It depends. If your business is young, small and doing a relatively modest amount of business, you can probably get away with the cash method. But keep in mind that if/when your business grows, it's going to become increasingly necessary for you to make the leap to accrual accounting.
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