When starting a business, one department that you can't afford to ignore is accounting. This is because sooner or later, your business will start to make profits, and you will need to keep a record of your transactions. But that may not be much of a problem like choosing which type of account to go with. In accounting, the two common types of accounts you can choose from when starting a business are cash and accrual types of accounts. The main difference between the two is the time in which financial transactions are recorded. The following is an analysis of how they both work.
Cash Basis Of Accounting
Under the cash basis, revenues are recorded on the income statement when cash is received from a customer. And the same rule applies to expenses; they are recorded when they are paid for. In other words, you don't record the transaction if you have not paid for the invoice received or if you have not received cash for the invoice sent.
Accrual Basis Of Accounting
Under the accrual basis, expenses and revenues are recorded when they take place, regardless of when the business pays or receives the money.
To get a clear picture that distinguishes the two types of accounts, imagine you are the owner of a computer installation business. Your business gets a tender and completes the job in a certain month, say November. However, according to the contract stipulations, you are to be paid two months later, which would be January in this case. Under the cash basis of accounting, you are going to record the transaction in January because it is the month that you will receive your payment. In accrual, though, you will record the income in November even if you will get you cash in January.
The Impact They Both Have When You Claim Tax Deductions
The type of account you choose has a say on how you are going to claim tax deductions. For instance, if you incur expenses in a certain tax year but pay them the next year, you are not in a position to claim deductions on these expenses when you are using the cash basis of accounting since you will record the transactions only after you have paid for the expenses. However, under the accrual basis of accounting, you will be able to claim deductions because transactions are recorded on financial statements when they take place, and not when cash is received or paid.
Share10 February 2016
Good day. I’m Linda and I run two family businesses — building contractor and aged care staff agency. It is quite a feat to juggle schedules and keep track of finances. I have become quite an expert with business management software. I have also learnt the vital importance of having good accountants to give advice and keep bookwork up-to-date. Prior to starting our family businesses, I honestly thought accountants existed to organise tax returns. I now understand that their jobs are much more complex and they can help your business prosper. I started this blog to highlight the numerous ways I’ve found that accountants can contribute to financial success. Please browse through the posts and I hope you find something useful within.