In the Trenches: Cash vs. Accrual Accounting

Like most small businesses, we use the cash accounting method to keep our books. Why? Because it’s easy. But there are downsides to it, which has me wondering whether we should consider switching to accrual accounting.

What’s the difference? The cash accounting method is very straightforward: When cash comes in the door, we record it as revenue. When cash goes out the door, we record it as an expense. That level of simplicity is why we — and so many others — use this method. After all, when you’re running a small business, the last thing you want to worry about is maintaining an unnecessarily complex accounting system.

If we used accrual accounting, we would need to book revenue when we earned it. For example, let’s say someone pays us $30 today to monitor flights they have scheduled in July. Using the cash method, we would record that $30 as revenue in February. Using the accrual method, we wouldn’t record the revenue until July, when we actually did the work. The cash comes in at the same time either way, but how it’s booked differs.

So, why do I care about all this? Well, I was looking at January’s numbers and was pleasantly surprised by the amount of profit we earned. Then it dawned on me that, because of the holidays, we’d paid our concierges their commissions at the end of December instead of at the beginning of January (as we normally would). So our expenses were higher than they should’ve been in December and lower than they should’ve been in January. Using the accrual method would prompt us to record revenue when it was earned and expenses when incurred, giving us a more accurate picture of how we’re performing.

Is it hard to switch? Well, sort of. We use QuickBooks Online, which provides an easy way to just change our reporting method. But that requires us to have properly entered everything for that method, and I’m not sure that we have. (Accrual accounting gets more complicated than the example I gave above.)

So, at the moment, I’m not inclined to change methods. But I am going to be more cognizant of the downsides of the cash accounting when I’m looking at our financial data. And, eventually, our small business will become big enough that we’ll have to convert. I might as well start getting used to the idea now!

About Brett Snyder

Brett is the Founder and President of Cranky Concierge air travel assistance. He also writes the consumer air travel blog, The Cranky Flier.
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2 comments
mharris127
mharris127

The accrual method is more appropriate for most businesses IMO (actually I can't think of a scenario where cash accounting would be more appropriate).  What if someone cancelled their request for services after paying?  With the accrual method it isn't an issue as you haven't recorded it as revenue yet (the unrecorded revenue would be sitting in a suspense account waiting for you to actually perform the service).  Same issue with large expenses which usually require accrual method in order to depreciate assets or record incremental usage of large amounts of non de minimus supplies (de minimus is the term we use to describe small transactions/ assets not likely to skew financial statements such as pens, paper, coffee, etc., I usually figure purchases not made to sell for profit and under $100-$250 qualify as de minimus for a small to mid size business) accordingly (cash method would decrease profits in one month and theoretically increase them for months on end until you need to buy more, repeating the cycle all over again).  With cash accounting it isn't so simple, you just inflated your profits for one month and deflated them for the next, misleading your stockholders and lenders (especially if a large purchase such as a mainframe computer or expensive machine/computer program is involved).  Most (if not all) banks require accrual accounting for this reason on financial statements required for taking out a loan as a business could theoretically use the cash method to inflate financial statements to mislead shareholders, banks, etc (or it could just happen as mentioned above about expense and asset accounting).  In my accounting classes we barely even discussed cash accounting since GAAP (governmental standards for businesses that issue stock and/or get large loans at government insured financial institutions) and GAAS (essentially GAAP for governments) require accrual accounting for all businesses and governmental units subject to the standards anyway.   The IRS requires use of a modified form of accrual accounting for tax returns as well.

cedarglen1
cedarglen1

Hello Brett.  I think you have nailed the differences to the wall.  SB operators should know the difference, but until much larger, the focus must remain on operating the business, not the accounting method.  As long as the every phase of the business requires your personal attention at some point, keep it simple and use the cash method.  In other words, run a travel services firm, not an accounting firm.  BEst wished for continued success. -C.

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