Accounting services usually offer two major services— cash basis accounting and traditional accounting. Both are used to keep finances in order, and to track outgoings and incomings. There are noticeable differences between the two. You need to understand both before you apply any of them.
Traditional accounting, also popularly known as accrual-basis accounting, is the most widely adopted in business. It is rather easy than cash-basis accounting.
In traditional accounting, income is recognized when it is earned. Similarly, expenses are recognized when bills come in.
Pros Of Traditional Accounting:
- It gives you a precise picture of your business finances and performance.
- It can help you to make better financial decisions as you always grasp over your financial records.
- It enables you to make budgets more strategically by not gasping what you have in your bank account, but what is coming in and going out over time.
- It can be beneficial in prospecting your company’s forthcoming financial health. Moreover, it can be effective, especially when seeking funding from lenders or investors.
Cons Of Traditional Accounting:
- You should always keep a keen eye on accounts receivable. Unluckily, you may withdraw several outstanding— without actual cash in your bank.
- You are urged to pay tax on income before it reflects in the bank account.
Cash-basis accounting recognises income and expenses— exclusively, when money changes consistently. In simple words, the system only records income only when it hits your account, and records expenses when the money leaves the account.
You can use cash accounting if your turnover crosses £79,000 or less for the year. It may increase to £158,000 if you claim Universal Credit.
Pros Of Cash-Basis Accounting:
- It is simple and easier to manage.
- It allows you to track cash within a certain period as cash simply in and out of your bank account.
- You are required to pay tax when you receive money, not when you issue invoices. For some businesses, it can help in cash flow.
Cons Of Cash-Basis Accounting:
- It is misleading because it can wrongly show you are in profit, but in reality, you may have bills to be paid.
- It is hard to make business decisions by seeing day-to-day financial records, rather than a long-term perspective.
Accrual accounting is the simplest, most efficient accounting method, when:
- Applying for a business loan, seeking investors, circumstances that expect sharing with an outside party (s).
- Your business sales cross more than $5 million per year.
- For businesses (e.g startups) that are thriving towards growth, accrual accounting is far more a powerful system as it will help them to make better financial decisions.
Accrual accounting is a widely accepted accounting principle (GAAP) and hence companies, both private and public, need to maintain GAAP-compliant. It requires much vigilance but can be solved through advanced accounting software and reliable accounting firms.
Cash-basis accounting is perfect for sole proprietors— especially in small-size companies. For them, the system is straightforward to manage.
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