Accounting Methods: Why accrual accounting is the best option for managing cash flow?
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Cash-basis and Accrual Accounting
As a business owner or manager, you must decide whether to use cash-basis or accrual accounting methods to record transactions and track your business’s income and expenses. The critical difference between these two methods is the timing of when transactions are recorded.
Cash-basis accounting records transactions only when cash changes hands, regardless of when the event that generated the income or expense happened. Cash accounting is just as it says. The system registers the transaction when you receive customer payments and pay your employees and suppliers. This method does not keep track of your obligations and outstanding receivables.
Accrual accounting records income and expenses when the right to receive a payment or the obligation to make a payment is originated. It gives you a more accurate picture of your company’s financial position. This system will record account receivables and accounts payable in your accounting software, providing helpful information for cash flow management. You will always know what you owe and what funds your customers owe to the business.
For example, you may bill customers $10,000 in invoices in September, but even when you do not receive payment for some of those invoices until October or November, your accounting system will show $10,000 as account receivables. The same goes for expenses. You may purchase $2,000 in inventory in September, but your payment is due in October. This transaction will add $2000 to your account payables. Using the accrual method gives you a good idea of the cash inflows and outflows you can expect for a given period and plans your cash management accordingly. You can see the changes in your cash balances by running a Cash Flow Statement.
Cash accounting is helpful for income tax purposes, depending on how the company is structured but does not provide useful information for managing cash flow.
Most accounting software lets you switch between cash and accrual bases with a simple mouse click.