There are two types of accounting methods accrual and cash accounting. Which type your company uses can have a major impact on the total revenue and expenses that appear in your financial reports.
Typically cash-basis accounting is used by smaller businesses who prioritise simplicity. Using cash-basis accounting a company records expenses and income as the cash is actually paid out and received.
There are some advantages to using cash-basis accounting such as:
- It’s easier to keep a track of your cash flow
- It’s suited to smaller businesses that mostly handle transactions in cash
The major disadvantage is that it doesn’t capture money owned to you or that you owe to others so it can be difficult to get an accurate picture of how the business is performing financially. Take a business we met recently which delivered training funded by various different governments and received lump payments on a few occasions a year. Using cash-basis accounting it was extremely difficult to track the health of their business because they either had ample cash or had been incurring expenses but were yet to receive payment.
Accrual accounting, whilst a little more complicated, is much better suited to businesses larger than microbusinesses or businesses who don’t get paid straight away.
Using accrual accounting you record expenses and sales when they take place as opposed to when cash is paid or received. For example using Accrual accounting our training business would apportion lump payments throughout the year depending on when the actual training was carried out. Now income and expenses are matched and the business has a true picture of their financial position.
A word of warning though, if you are using accrual accounting you need to keep an eye on your cash flow because any issues won’t necessarily appear in your financial statements.
How to introduce accrual accounting?
If you are already using an account or bookkeeper you simply need to ask them to start providing you with accrual accounting financial statements. Speak to an MGI advisor to make this happen.