When setting up accounting for your business, one of the first decisions you'll need to make is whether to use cash or accrual accounting. Each method has its advantages and is suited to different types of businesses.
Cash accounting is typically used by sole proprietors or small businesses that do not carry inventory. With cash accounting, income is recorded when you receive payment, and expenses are recorded when you make a payment. At O'hare Consulting we employ a straightforward and simplified way to track your finances, making it ideal for businesses that operate on a week-to-week basis.
Accrual accounting, on the other hand, is used by businesses with revenues over $25 million, as it is a requirement for larger businesses. With accrual accounting, income is recorded when you create an invoice, and expenses are recorded when you receive a bill or enter a purchase order for payment. This method provides a more accurate picture of your financial health, especially for businesses with money in the bank and a steady cash flow.
Accrual accounting generates key reports such as accounts receivable and accounts payable, which are crucial for managing cash flow. Accounts receivable shows the money owed to you, while accounts payable shows the money you owe to others. These reports are essential for understanding your pipeline for revenue and expenses.
The method you choose will depend on your business's size and financial needs. Cash accounting is best for small businesses and sole proprietors who operate on a week-to-week or month-to-month basis. It allows you to track your cash flow closely and make informed decisions about spending.
Accrual accounting is more suitable for larger businesses with a steady cash flow. It provides a more accurate picture of your financial health and helps you manage accounts receivable and accounts payable more effectively.
Whether you choose cash or accrual accounting, it's essential to use a good accounting program that allows you to run both types of reports. This will give you the best overall picture of your business's financial health and help you make informed decisions about its future.
