Two methods are used to track financial reports – cash basis and accrual basis. Knowing what basis you are looking at when reviewing your financial reports is important. So let’s take a moment to dive 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 based on whenever the cash changes hands. That means something is not income until you are paid for it. And you don’t incur an expense until you pay for it.
Contrast that with Accrual basis – in Accrual basis accounting, you recognize the income when you perform the work or earn the income. Generally, income is recognized when you issue an invoice for that work. Same with expenses – you incur the expense when 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 recognizing income or expenses and paying 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 business’s productivity. 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 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 businesses, like retail stores, may more effectively be cash-based businesses. However, this is probably a more straightforward approach when there is no discernible timing difference.
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 about cash basis – i.e., how much money do I have in my checking account right now? At Zumifi, 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 are already committed to those. Accrual basis books give you a fuller picture.
Don’t confuse any of this with how you file your taxes. Almost every business (except our clients with inventory) files their taxes on a cash basis. That is to your advantage, so you are not paying taxes on the income you haven’t received yet. But that’s for taxes. So keep that separate in your mind.
At Zumifi, we strongly believe that you need day-to-day financial reporting that gives you the clearest picture of your business’s performance. When you know your numbers, you become the master of your destiny!
Zumifi- Keeping You in the Know!