Cash Vs. Accural Accounting
Cash and accrual accounting procedures enable organizations to record and report their operating data. All organizations, including government agencies, nonprofits and businesses, rely on these policies to show the rest of the world how they performed over a period of time. If you are a business owner, understanding the differences between cash accounting and accrual accounting can help you run corporate operations efficiently.
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Cash Accounting
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Cash accounting enables you to record transactions that involve cash, such as liquidity inflows (receipts) and outflows (disbursements). Cash inflows include payments from customers and interest income on savings accounts. Cash outflows include payments to vendors. For example, your company's ledger may indicate the following transactions at the end of the month: customer checks ($10,000), vendor payments for rent, insurance and utilities ($2,500) and quarterly state tax payment ($5,000). To record these transactions, you debit the cash account for $10,000 and credit it for $7,500 ($5,000 plus $2,500). In accounting terminology, debiting cash--an asset account--means reducing the account's balance. This is distinct from the banking terminology. You also need to debit operating charges and fiscal expense for $2,500 and $5,000, respectively. The net effect of these entries is a $2,500 ($10,000 minus $7,500) increase in your cash account.
Accrual Accounting
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Unlike cash accounting, accrual accounting conforms to financial reporting norms, such as generally accepted accounting principles and international financial reporting standards. As a result, you should opt for accrual accounting if you plan on listing your company on a securities exchange in the future. Selecting accrual accounting may also be beneficial economically, especially in borrowing transactions or equity sales to private investors. As a business owner, you may seek financing to fund short-term operations and improve market share. In accrual accounting, you record revenues when they are earned and expenses when they are incurred, regardless of whether operating transactions involve cash. Simply put, you record revenues when clients receive goods and enter expenses in accounting books when you receive vendor bills. For example, you may receive the following notices from business partners at the end of the year: utilities due January 15 ($1,000), customer checks dated January 23 ($10,000) and vendor bills due January 30 ($5,000). To record these transactions, you debit the utilities expense account for $1,000 and credit the vendor payables account for the same amount. Then debit the materials purchased account for $5,000 and credit the vendor payables account for the same amount. You also need to debit the customer receivables account for $10,000 and credit the sales revenue account for the same amount.
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Financial Reporting
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The accounting method you choose affects how you report corporate operating data. Cash accounting reports cover only transactions involving cash. These statements may not provide an accurate view of your company's performance, especially if your clients do not pay for goods on delivery.
Expert Insight
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You may hire an accounting specialist, such as a certified public accountant, to analyze your company's operations and recommend the method that's appropriate for the company.
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