Have You Considered Switching From Cash Basis Accounting?
Posted on: 10 July 2023
Small business bookkeeping is often performed using cash basis accounting. This means you record transactions when cash exchanges hands. Unfortunately, cash basis accounting has serious issues. As a result, you should consider switching to a different method if you're still using it. Doing so can mean laborious and time-consuming work. Still, you might benefit from creating a clearer picture of your business's circumstances. An accounting firm specializing in small business bookkeeping can help you with making the switch.
Cash Basis Has Restricted Use
Accounting isn't a perfect science. After all, it's people describing complex realities using summarized numbers. As a result, it's often possible for something to be accounted for in more than one way without breaking the rules. Despite this, it's telling that cash basis accounting isn't allowed in a wide range of contexts. For instance, the IRS has strict rules on who can and can't use this method. One example is how it's invalid for anyone who sells on credit, while another is how it's off-limits to most companies that maintain inventories for whatever reason.
This treatment isn't limited to the IRS. Other interested parties will judge your business based on your financial documents. Cash basis accounting can hurt your credibility because its results are less informative than those produced using other methods.
Cash Basis Gives You Limited Insight
Cash basis accounting gives you less insight into your business's circumstances. One of the most basic accounting rules is something Accounting Coach calls the Matching Principle. This says corresponding revenues and expenses should be recorded in the same periods.
Imagine you've paid for a year's worth of insurance. Cash basis accounting requires you to treat the entire sum as insurance expense in the month you paid it. In contrast, accrual basis accounting says to turn the payment into a current asset called prepaid insurance, which is deducted as insurance expense bit by bit throughout the year until it runs out at the end. The latter is a more faithful reflection of how your spending enables your business to make money. That gives you a better understanding of how your business is currently doing. Moreover, it makes it easier for you to predict future trends.
Cash Bash Uses a Single-Entry System
Modern accounting uses double-entry bookkeeping. That means every change to an account produces a corresponding change to another account. For example, you debit supplies and credit cash when you pay for office supplies. Similarly, you debit cash and credit revenue when you make a sale. Double-entry bookkeeping gives you more details about your business's financial situation. On top of this, it makes it easier to notice errors and other issues when accounts fail to match up.
Meanwhile, cash basis accounting uses single-entry bookkeeping. Its primary virtue is that it's easy. Unfortunately, that's only true so long as you see a small number of daily transactions. Once your business has become too big, the problems caused by single-entry bookkeeping's opaqueness swiftly overwhelm any benefits from ease of use.
Reach out to a bookkeeping firm to learn more about your options.
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