Which is better? -Cash method vs. accrual

method

Working on accrual and cash accounting and wondering which method is better for

which kind of business?

Both the methods help in keeping track of business’s

income and expenses with their own advantages and limitations

to be considered before a decision.

The two methods differ only in timing of recording the transaction. In cash accounting, revenue is not counted until cash is received and

expenses are not booked utile cash is paid.

Now, you must have some knowledge about the cash method vs. accrual method to be able to take a decision as to which

is better.

Cash basis provides more accurate picture of how much cash the business has while accrual basis leaves one in a dark as to what cash reserves are available.

Cash basis depicts misleading picture of long term profitability while accrual basis provides true picture of profitability.

• A business can exercise more control over cash accounting than accrual accounting.

• The IRS allows many small businesses to use the cash basis of accounting.

• Cash accounting basis allows small businesses to reduce their taxable income that can be done through simple manipulations in the statement; for example, prepaying expenses and purchasing supplies right at year end.

• This advantage of being able to manipulate income is also a big limitation of cash accounting basis with potential lenders and investors.

• Lenders and investors are always found skeptical of financial statements of cash accounting.

• However, on the other hand accrual accounting is more representative of the actual situation for it provides more useful and reliable financial information.

Facts about Cash Accounting basis

• Cash accounting is not suitable for businesses that sells products on credit and the billing is done in a later date because there is no provision to record and track money due from customers at some time in the future in this method. The same situation is also true for purchases.

• Cash accounting is easy and therefore suitable for small businesses ad sole proprietorships.

Facts about Cash Accounting basis

• Its good to start out with cash-basis accounting. • Matching revenues earned with money laid out for expenses is a

tough task with cash accounting basis, however, tracking cash flow is very smooth.

Facts about Accrual Accounting basis

• Suitable for large scale business firms.• Seasonal business firms can establish short-term lines of credit

through the bank to maintain cash flow through the lean times. • Monitoring cash flow on a weekly basis is a good practice and is

possible only with accrual accounting. • Matching revenues and expenses is much smoother than tracking

cash.

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doubts?

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