When it comes to running a successful business, keeping an eye on the numbers is essential. But one decision that’s often overlooked, especially by new business owners, is how those numbers are recorded. This is where the choice between cash and accrual accounting comes in.
It might not seem like a big decision, but the method you choose can have a major impact on your cash flow, tax planning and overall financial clarity.
So, what’s the difference and which one’s best for you?
The basics: Cash vs Accrual
Let’s start with a quick overview of the two methods:
- Cash accounting is the simpler of the two. You only record income when you receive payment, and expenses when you pay them. Quite simply it’s a “money in, money out” approach.
- Accrual accounting is where you record income when it’s earned and expenses when they’re incurred, even if the cash hasn’t yet changed hands. For example, if you send an invoice in April but get paid in May, the income is recorded in April.
The advantages and disadvantages
Here’s a quick breakdown of the pros and cons of each method:
Cash accounting advantages:
- Straightforward to manage. Ideal for sole traders, freelancers and small businesses.
- Gives a clear view of what’s in your bank account.
- Offers some flexibility around tax timing, delaying income or bringing forward expenses.
Cash accounting disadvantages:
- Doesn’t offer a complete picture of your financial position.
- Not suitable for businesses with stock or large amounts of receivables/payables.
- Not compliant with GAAP, which could be an issue if you plan to grow or raise funds.
Accrual accounting advantages:
- Provides a more accurate view of profitability.
- Matches income with related expenses, crucial for tracking performance.
- Required if you’re dealing with investors, banks, or plan to scale up.
Accrual accounting disadvantages:
- More complex and often needs accounting software or support.
- Can make cash flow harder to interpret. For example, you might look profitable but have limited funds on hand.
Let’s explore some real-world examples
For a retailer an accrual is usually better:
Imagine you run a clothing shop. You buy stock in January, it arrives in February, and you sell it in March. Accrual accounting helps you align the costs with the income, giving you a true picture of your profit margins.
For a freelancer a cash method makes sense:
If you’re a freelance designer who invoices clients and gets paid promptly, with little overhead, the cash method keeps things simple and gives you real-time visibility of your finances.
Thinking of switching?
Yes, you can switch from one method to the other but it’s not something to do lightly. You’ll need to:
- Adjust your books to make sure income and expenses aren’t duplicated or missed.
- Ideally, work with an accountant to handle the transition smoothly, especially if you have outstanding invoices or bills.
It’s also best to make the switch at the start of a new tax year.
Let’s summarise:
- If you’re just starting out opt for cash
- If your managing stock or inventory opt for accrual
- If you’re looking for funding or investment opt for accrual
- If your focused on cash flow opt for cash
- If you’re growing rapidly opt for accrual
The right accounting method depends on the nature and goals of your business. Cash accounting is simple and effective for many small businesses. But if you’re planning to grow, manage stock, or report to investors, accrual accounting may be a better long-term fit.
Not sure which route to take? Give us a call, a short conversation now can save a lot of confusion and possibly money down the road. Call us on 01173 700 079 or e-mail hello@steppingstonesaccountancy.co.uk.
You can also book a free 20-minute call with Yarka – https://calendly.com/yarka-ssa/20min
