Every small business needs to keep track of its income and expenses. For the smallest businesses, recording income as the money that is received might be easiest. This is known as cash-basis accounting. Show
But as your business grows, you may need to track the revenue that is outstanding — that’s where accrual accounting comes in. But what is accrual accounting, exactly? Is one better for some types of businesses more than others? Read on to find out. What is an accrual in accounting?An accrual in accounting is a recording of a transaction (either expense or revenue) when the transaction takes place, rather than when money changes hands. For example, you might record revenue on project completion rather than on invoice payment, or you might record an expense when it’s incurred but not yet paid for. Accrual-basis accounting generally provides a more realistic idea of the income and expenses of a business during a given period than cash-basis accounting. However, this comes at the expense of obscured cashflow — your records might show a lot of revenue, but if the invoices are outstanding, your actual bank account funds might be low. Accrual basis accounting versus cash basis accountingAccrual-basis accounting and cash-basis accounting are both valid options — like almost anything in business, each choice has its pros and cons. The primary difference can be seen when revenue and expenses are recorded in your ledger — immediately or when the transaction clears and money leaves or enters your account. Choosing between cash accounting and accrual accounting often comes down to the size of your business, but there may be other factors that are relevant for you. Let’s explore. Pros and cons of accrual accountingWhile accrual accounting is popular among many Australian businesses, it does have its positives and negatives. Let’s take a closer look at some of the main ones below: Pros of accrual accounting1. Immediate feedbackInvoice payments are rarely immediate, which can mean delays in when you record transactions and view changes to your business’s financial status. Accrual accounting prevents this issue. 2. Plan with confidenceYou have a much more accurate picture of your business’s finances with accrual accounting, so you can more easily plan for future changes. 3. Improve financing optionsSince accrual accounting provides a more comprehensive (and often more accurate) view of your business, it can help make it easier to get approved for long-term financing — something that’s important for many small businesses. Cons of accrual accounting1. More complicatedAccrual accounting tends to be more complex, simply because you have to watch your invoices, rather than just your bank account. 2. Potential inaccuracies in cashflow forecastsSince the income recorded in your account is based on projects completed or items delivered, but not on actual payments, it can be tougher to forecast exactly when money will hit the account. 3. Pay tax on unrealised incomeYou may have to pay taxes on your recorded income before the customer actually pays the invoice. If they end up not paying, the process to reclaim the taxes paid can be time consuming. Who uses accrual accounting?Larger, more complex businesses tend to use accrual accounting. Cash accounting definition: What is cash accounting?Cash-basis accounting is essentially the opposite of accrual accounting — instead of expected payments, you record the actual payments, either to or from your business. Pros and cons of cash-basis accountingSimilar to the accrual accounting method, cash basis accounting has its own set of pros and cons. We’ll take a closer look at each of these below: Pros of cash accounting1. Simple single-entry systemSince you’re recording actual income and expenses, the math with cash accounting is much simpler. There’s no need to track accounts receivable or payable. 2. Potential tax advantagesWhen you’re recording only the income you’ve actually received, you’ll pay taxes on money you have (as opposed to money you’re expecting to have in the future). Additionally, you can control the timing of transactions for more favourable tax consequences. Cons of cash accounting1. Doesn’t show the full pictureCash-basis accounting doesn’t show your business’s liabilities, so you don’t get a clear picture of how much money you truly have to spend. 2. Restricted use casesIf you offer credit, or need inventory to account for income, you may not be able to use cash accounting. 3. Ineffective for planningSince cash accounting only shows a snapshot of your finances, it can be difficult to do any kind of long-term planning or analysis. Who uses cash accounting?Cash accounting is generally used by smaller, newer businesses or those with simpler needs and structures. Categories in accrual accountingAccrual accounting consists of a few different types of transactions. Since it tends to be more complex than cash basis accounting, it might be helpful to define what some of the key transaction categories are. Accrued revenueWhat it is: Revenue for services performed during one month but billed in another. A common example of this is utility services like electricity or water. The company provides the service, reads the meter, and sends the bill, which is paid the following month (“following” being the key word). How it’s recorded: Accrued revenue is recorded by crediting the revenue account and debiting the accounts receivable. Accounts receivable is the remaining balance of money owed to a business for products or services. Accrued expensesWhat it is: An accrued expense is simply an expense your business has incurred but hasn’t been billed for yet. Salaries are one of the most common accrued expenses. Sick days and PTO for employees are other examples. How it’s recorded: Accrued expenses are recorded by debiting the expense account and crediting the accounts payable — essentially the reverse of recording accrued revenue. Example of accrual versus cash accountingTo help illustrate the difference between accrual and cash basis accounting, let’s run through a quick example. Imagine you run a small business that sells landscaping services to other local businesses. Many of those businesses have Net30 or Net60 payment terms. This means the buyer is expected to pay within 30 or 60 days of the goods being dispatched, or the services rendered. These terms can result in actual cash payments being delayed for a month or two after invoicing. For the current month, you perform $40,000 worth of work for these local businesses. This is your most successful month yet! And if you use accrual basis accounting, your records show the full $40,000 as revenue. Now let’s say you use cash basis accounting. Only a handful of the businesses you performed work for actually paid their invoices the same month, totalling $8,000. When you go to review your books, you don’t see that it was your best month yet — all you see is that $8,000. This is one of the reasons that accrual accounting is so much more common — by using cash basis accounting, you’re missing the big picture of your business and may not know when to make big decisions, such as purchasing new equipment or hiring a new employee. With accrual accounting, you get the full picture of the health of the business. The effect of accrual accounting on taxesYour choice between accrual and cash accounting has important tax implications. That’s because with cash accounting, you record income when you receive it, which may be a month or more after you actually earn it. If those months fall on the line between tax years, it can have a drastic impact on your liability. The same is true for expenses you might deduct. As an example, let’s say in the month of June 2021 you invoiced clients for a total of $10,000 but only received payments for $2,000. With cash accounting, you would report $2,000 on your 2021 taxes, and the rest would go on your 2022 taxes when you file them. With accrual accounting, the full $10,000 would go on your 2021 taxes. Is accrual accounting right for your business?Is your business growing? Are your accounting needs becoming more complex, with an increasing number of variables and outstanding balances to juggle? If so, it might be time to consider accrual accounting. Accrual accounting is based on the idea of tracking income and expenses when they are earned or incurred, rather than when money changes hands. As such, they can give you a much better long-term view of your business’s activity and health. If you’re worried about complexity, remember that accounting software can take care of a lot of the more manual, tedious, and error-prone work for you. MYOB has a small business accounting solution perfect for growing companies. Start a free trial today!
Accounting is an ongoing process, one that most people take years to master. Whilst some aspects of accounting are regulated and need to look a certain way, like balance sheets, for example, this isn’t the case for everything. When it comes to bookkeeping, business owners have some choice in the methods they use. Timing is everything, and the method an ecommerce seller uses will dictate a number of important things for their business. And ultimately, whether the company survives, thrives, or dies. In this article, we will focus on the two most common bookkeeping methods: Accrual accounting and cash accounting. We will explore what they mean, how they work, and the rationale for why accrual accounting is hands-down the favorite for ecommerce. We’ll also show how books can be set up to do this automatically, so sellers get all of the accrual accounting benefits and none of the headaches! In this guide, part of our ecommerce fundamentals series:
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Let’s get stuck in.
An Overview of Accounting and Why It MattersBefore we dive straight into bookkeeping methods, let’s take a step back. Why should we spend time and money on accounting and bookkeeping in the first place? Accounting is fundamental to your business. It is the process of summarizing, analyzing, and reporting on the financial transactions within a business. It’s about managing the money, and understanding its movements. And since your money is the blood flow of your business, powering its essential organs, its proper management is essential. Accounting gives businesses:
Businesses are fuelled by money. Without accounting, running a compliant, profitable and scalable business is practically impossible. So, how does it work? How Accounting Works TodayBefore we dive into the mechanics of accounting, let’s cover a couple of definitions and the statements businesses use to understand their finances. The terms bookkeeping and accounting are sometimes used interchangeably, but they are different things.
The standard documentation that businesses need like income statements, cash flow statements and balance sheets rely on both detailed bookkeeping and accurate accounting. We’ll talk more about what these are below. Financial statementsCash flow statementsThese statements are usually split into three sections: operating, investing, and financing activities. They help you track how much money is moving into and out of your business, and where it’s coming from or going to. The key concern in your cash flow statement is that your operating activities total is positive. This indicates that your business is generating enough cash to stay in the black. If you want to invest, you’ll need this operating activity to be enough to cover that too. If it’s not, you may be propping up your business in unsustainable ways, like using credit cards or loans. And that’s not something you want to rely on in the long term. Opening cash + cash received (or forecasted to be received) - cash spent (or forecasted to be spent) = closing balance. Income statements (or P&Ls)The income statement, sometimes referred to as a “P&L”, “PNL”, or profit and loss statement, lays out your sales, costs of goods sold, and expenses, to give you your profit. It is a record of your past income, up to the present day. You can track your sales patterns and trends, and you want to ensure that these rise in parallel with your net income. If your sales rise but your income doesn’t, you can use the statement to figure out where your money is going. Profit = income (or revenue) - expenses. Balance sheetsThis is a bird’s eye view of everything your business owns or owes. In a snapshot, it tells you whether your business has value or not today. Where cash flow statements and P&L are your business’ road maps, your balance sheet is the globe. It consists of assets (what your business owns), liabilities (what your business owes) and equity (the value of your company: assets - liabilities). The balance sheet provides an opportunity to look for errors and patterns in financial activity. By comparing these snapshots, you can see an overview of your business’ monthly performance, and check that all your numbers make sense and are recorded accurately. If your equity is trending up over time, that’s a good sign that your business is healthy and on the right track. Assets - liabilities = owner’s equity (or capital value) Real-world examples of these statementsIn this video, Catching Clouds founder Patti Scharf shows you examples of these financial statements and explains what ecommerce sellers should be looking for within them. Skip to 9m:30s for cash flow statements, 5m:50s for income statements and 0:40s for balance sheets. If you use a good accounting software partner for your ecommerce business, these statements should be generated automatically for you. Ask your bookkeeper or accountant to help you interpret them and look for weak areas. Bookkeeping methodsNow that you know how we use financial information and diagnose issues with it, let’s take a step back and look at how this information is recorded in the first place. The foundations of accounting today originated in 16th century Europe, to help rationalize growing trade and commerce. These foundations took the shape of the double-entry bookkeeping system. And it’s understanding this system that will help in our debate about using cash vs. accrual accounting later on. Double-entry bookkeepingDouble-entry bookkeeping refers to a method of entering accounting records. It works on the basis that every credit entry to a business’ books should have a corresponding debit entry, and vice versa. This keeps books balanced, hence the name, “balance sheet”. It is used to satisfy the accounting equation we also mentioned above: Assets = liability + equity As credits and debits are offset, they should always be equal. If they are not, this indicates an error in the process and helps accountants diagnose problems. It’s worth noting at this point that “credits” don’t always mean increases and “debits”, decreases. For example, debits to an expense account increase its balance, and debits to a revenue account decrease its balance.
The accrual method of bookkeeping gives businesses a clearer understanding of the relationship between their revenues and expenses. This, in turn, helps provide a more accurate picture of assets and liabilities for a business’s balance sheet, because both are recorded at the time they are accrued. Let’s look into accrual accounting vs. cash accounting a little more deeply now, to see how the former makes most sense to ecommerce businesses in particular. Cash And Accrual Accounting BasicsThe cash and accrual accounting methods are ways to manage business bookkeeping.
The key difference between the cash and accrual accounting system comes down to timing.
Cash accounting definitionCash accounting involves recording income and expenses when money changes hands. Income is recorded when money is received and expenses when bills are paid. Cash accounting is used because it is simple (sellers can pretty much go off of bank statements, and they know exactly how much money their business currently has). Cash accounting exampleFor ecommerce sellers, sales are counted when the settlements come in from the platform. So if you sell on Amazon, you only record sales once the money has come into your bank account. Which types of businesses typically use cash accounting?Cash accounting can be effective for businesses that have little to no time delay between when transactions occur, and when money changes hands. Cash accounting may suit restaurants, for example. There isn’t much of a delay in when they get paid and when their bills are due:
Accrual accounting definitionThe accrual accounting method involves recording transactions at the time sales are made or orders raised, even if the money hasn’t changed hands yet. It focuses on the movement of value as opposed to immediate cash handling within a business. Income or expenses can be recorded if either:
Accrual accounting is used because businesses often operate on credit, and settle debts a while after a transaction might have taken place. Staying on top of what is owed both to a business and by that business is crucial to stay afloat. The accrual accounting method is required by the GAAP (generally accepted accounting principles) for larger businesses:
Accrual accounting exampleIf a transaction took place on Amazon on 5th June, accrual accounting would record that date against that transaction, even if the settlement from Amazon didn’t actually arrive until 10th June. Cash accounting would record it on 10th June, when the money arrived. Which types of businesses typically use accrual accounting?Larger businesses or those with a greater time difference between when they receive money and need to pay their bills should use the accrual accounting method.
Pros and cons of accrual accounting and cash accountingIt might seem like only counting cash when it’s in the bank is the smartest way forward, but that’s not necessarily true. Check out what the methods mean for bookkeeping below:
See those “cons” next to accrual-based accounting? Well, keep reading to see how A2X removes those from the picture, making all those benefits accessible to ecommerce sellers with none of the hassle. Why Is Accrual Accounting Better For Ecommerce Sellers?There are many different advantages of accrual accounting for ecommerce sellers. Aside from the fact that the GAAP requires this method from businesses that reach a certain size, even smaller sellers should consider it from the beginning too. Unlike the restaurant example we discussed under the cash accounting section, selling online doesn’t typically involve immediate payments both to or by a seller. Certain transactions might be made in anticipation of a need to settle up later on. An example of this might be using a credit card to cover fees or inventory purchases before paying it off later, when the cash is available to do so. Sellers need to forecast cash flow in order to do this successfully, and to avoid deficits that could incur extra fees and eventually put them in debt. An additional benefit of accrual accounting is to enable sellers to estimate whether they need funding to grow and how much to request. If they are considering a loan, this will help to ensure they only take out as much as they need. SellersFunding is one example of a service for ecommerce sellers to raise their capital this way. What the accrual accounting method gives sellers
How To Do Accrual Accounting Using Smart AutomationIt probably sounds by now like accrual accounting is a bit of work. While this is true, it doesn’t mean everything has to be done by the business owner themselves. There are plenty of resources specially designed to help ecommerce sellers manage industry-standard, accurate books in less time - zero existing expertise required. Number crunching is a time-consuming, easy-to-delegate task. By automating it, that redundant vegetable is gone from the sellers’ plate, making room for something far more exciting. Perhaps a new revenue stream, product or client? For optimized, industry-standard ecommerce books, you need: The crucial first step for any ecommerce seller: Cloud-based accounting software. Sellers of any size should think about investing in this before any other automation technology. Why? Cloud accounting software gives ecommerce sellers:
Plus, there’s nothing to install or download. Everything is based in the digital stratosphere for easy but protected access. We recommend Sage, QuickBooks and Xero for ecommerce accounting. A2X integrates with cloud accounting software and ecommerce platforms Amazon, eBay, Shopify, Etsy or Walmart. It captures settlement data from the platforms and calculates each line item for each bank deposit, organizing them into accrual accounting journal entries. A2X gives ecommerce sellers:
Check out how A2X works here:
Start a free trial for A2X anytime via the dedicated platform links below: For those interested in expanding, other platforms can be integrated into one A2X account later on. Check out verified A2X reviews here. Check out more detailed A2X case studies from sellers and accountants here. Accrual Accounting = Greater Understanding = GrowthAccrual accounting helps sellers get to know their business on the kind of level required to make the big decisions. Decisions that could be the difference between sink and soar. Sellers should start with cloud accounting software. Once that is set up, wherever they are in their journey, A2X can go in and organize books via the accrual method - backdated if need be. No more assumptions, no more guesstimates - steer your business on accurate, reliable numbers from now on. Next in the Series…This blog is the third part of the A2X ecommerce accounting fundamentals series. So far we have covered the core concepts of ecommerce accounting and what makes it different. Now that we’ve looked at bookkeeping methods above, let’s explore a great way to manage your cash flow: Profit First for ecommerce sellers. |