Accrual or cash accounting? What does that mean? Actually, many business owners don't even have a clue as to what it is, thus hurting their cash flow when it comes time to pay taxes. These two types of accounting define how your financial data will be showing up in your financial statements.
When your company operates as accrual basis accounting, revenue and expenses are earned and expenses are considered recognized. Revenue is earned under accrual accounting when the product is delivered or services have been provided. Expenses are recognized in the period that revenue is recognized (the matching principle otherwise meaning matching revenue to an associated expense). Take this example. Customer A is purchasing some goods from Company A. They decide to buy $5,000.00 worth of merchandise, but only pay for $2,500.00 of it, considered as a down payment. According to accrual accounting, the cash is received but revenue or the associated expense is not recognized yet, since the merchandise is not completely paid for or delivered to the customer. Once the customer pays off the full balance of the merchandise, the associated revenue (for the sale) will be recorded, as well as sales and excise tax expenses, freight and delivery charges. If your company sells a lot of merchandise, your cash flow will be managed much better if you follow accrual accounting, or not recording a sale until the sale is completed. This will allow you to cut down on monthly/quarterly excise tax payments, and will decrease your overall tax bill at year end, since you will not be including sales that are still open on your books.
Cash basis accounting is a type of accounting in which revenue is recognized when cash is received and expenses are recognized when cash is paid. In this type of accounting, all sales are recorded as soon as any cash for each specific order is received.
Copyright Jeanine Pfeiffer