There are two methods used to track financial reports – cash basis and accrual basis. It is important to know what basis you are looking at when you are reviewing your financial reports. So let’s take a moment to dive a little deeper into each method, the differences between the methods, and why you would use one method versus another.
Cash basis accounting means that you are looking at income and expenses solely based on whenever the cash changes hands. That means something is not income until you are actually paid for it. And you don’t incur an expense until you actually pay for it.
Contrast that with Accrual basis – in Accrual basis accounting you recognize the income at the time you perform the work or earn the income. Generally, this means income is recognized when you issue an invoice for that work. Same with expenses – you incur the expense at the time your vendor bills you for that expense, not when you pay for it. So with Accrual accounting, you are tracking Accounts Receivables and Accounts Payable to track the time difference between when you recognize income or expenses, and when you actually pay for them.
Most businesses we work with benefit from tracking things on an Accrual basis. Yes, it has a few more moving pieces, but it often provides a more accurate view of the productivity of the business. In accrual basis books, we can see the productivity of a prior month for example based on how many dollars the business was able to bill that month, which of course is very different from knowing how much cash was received. So we encourage most of our clients to track their books on an accrual basis.
There are exceptions – some business, like a retail store may more effectively be considered cash basis businesses. When there is no discernible timing difference, this is probably a more straightforward approach in those circumstances.
Choosing which basis to use for your internal tracking is important. You want a good “fit” for what you want to be able to see in your financials. Many small business owners think in terms of cash basis – i.e. how much money do I have in my checking account right now? At ZümiFi, we believe we can answer that question for you quite simply and still provide you with accrual basis books that allow you to see what’s coming – what is the income you will be receiving because you already earned it, and what are the expenses that you have to pay if you haven’t already because you already committed to those. Accrual basis books give you a fuller picture.
Now, don’t confuse any of this with how you file your taxes. Almost every business (except our clients with inventory) file their taxes on a cash basis. That is to your advantage so you are not paying taxes on the income you haven’t actually received yet. But that’s for taxes. Keep that separate in your mind.
At ZümiFi, we strongly believe that you need day to day financial reporting that gives you the clearest picture of how your business is performing. When you know your numbers, you become the master of your destiny!
ZümiFi- Keeping You in the Know!