You must have heard a lot from people talking about accruals accounting and cash basis accounting, however, what is it exactly might always confuse your mind. It is mainly about the timing that is connected with the major differences between cash basis accounting and accrual accounting. It matters a lot what you aim to make a record of your business expenses and revenue. Some people record the details just at the time when they receive any money or make a payment to someone, this practice belongs to cash basis accounting. On the other hand, some businesses follow the practice of maintaining the record details at the time of receiving the business bills or when they raise an invoice, this practice belongs to accrual basis accounting.
Most of the people who are associated with accounting are of the view that accrual accounting is known to be the most powerful tool. This further helps a lot to manage the business activities, however, we can not deny the benefits and uses of cash basis accounting here. This guide is based on the frequently asked questions about which is the most suitable accounting for the type of business they carry out. For a fair decision, we will begin delving in with a basic understanding of what the cash basis of accounting and accrual accounting is. Along with the basics, we will bring the downside and beneficial factors into the limelight as well.
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What is Cash Basis Accounting?
It is all a matter of money and time as there are several businesses that only use cash basis accounting when the money goes from one hand to another. This means that such businesses use this type of accounting to recognise business expenses and income only. The invoices sent and raised are not included as part of income in this case. On the other hand, the business expenses are not considered associated with the bills only.
People often confuse the name cash basis with the received payments, however, that is not the case at all. This is because of the factor that you can do cash basis accounting even when you are making the payments electronically. This type of accounting process is famous among business that has no inventory or by sole traders.
1- How Good is Cash Basis Accounting?
Some of the popular benefits of cash basis accounting include the following:
- It helps to identify the money in hand through the simple process.
- You will be charged tax on the amount of money you have received not in the issued invoices.
2- What is the Downside of Cash Basis Accounting?
The downside of cash basis accounting includes the following factors normally:
- Cash basis accounting is not always accurate. It sometimes shows the profits before you have paid your business bills.
- Because of the day-to-day financial details, it is not much help when it comes to making important management decisions.
What is Accrual Accounting?
In the case of accrual accounting, the practice of recognising the income is done when an invoice is raised for the consumers. In the case of the business bills, this will be dealt with as a business expense even if the owner does not pay the bills for a period of a month.
1- How Good is Accrual Accounting?
Just like cash basis accounting, there are certain beneficial factors associated with accrual accounting. These include the following:
- It is an easy and simple process to carry out in the long run in terms of finance.
- This will allow you to take managerial decisions with a clear vision.
- The picture that you will view about your financial position and business performance will tend to be more accurate.
2- What is the Downside of Accrual Accounting?
The downside of accrual accounting is associated with the following listed factors:
- The workload increase with the use of this type because you will have to monitor your invoices other than the bank accounts.
- You will be bound to pay the tax on your income regardless of whether your consumers have paid or not.
- The tax can be claimed back in case the customer reneges.
Cash Basis Accounting vs. Accrual Accounting
In the case of accrual accounting, you will be able to get an accurate indication of your performance of the business and financial position. This is because it is an accurate view of the business expenses as well as the income. Over a period of a month, the view will be easily accessible with the help of accrual accounting.
On the other hand, the business that uses cash basis accounting for the purpose of tax will help them to maintain tabs on their cash flow. Cash accounting can not be used on its own. The case of accrual accounting demands more work, however, the results you want to achieve are more accurate.
The Bottom Line
Now that you have gathered a fair amount of information about the accrual accounting for your business, we can bring the discussion towards wrapping up. We can say that there are factors related to the downside of accounting and beneficial for both types. The best is to identify your business needs and then opt for the most suitable option to view your business financial position and other records. This will allow you to gain confidence and make the right business choices. We hope these few minutes of reading will help you to make the right accounting decision for your business in the future.
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Disclaimer: The information about the accruals accounting for your business provided in this blog includes text and graphics of general nature. It does not intend to disregard any of the professional advice.