Monday, June 13, 2011

Cash or Accrual-Based Books

Unless you have zero employees and are very small, chances are you will get the most benefit by keeping track of your books on an accrual basis. Why? Because accrual is about managing and improving performance, profit, and cash. Cash-basis accounting cannot help you do that.

Rather than take time in this post to discuss the differences between and the pros and cons of cash and accrual-basis accounting, please read my guest post on Melinda Emerson's Succeed As Your Own Boss website: Why You Need Both Cash and Accrual Books.

In this post I recommend you keep your books on an accrual-basis and then let your tax CPA convert your information to cash-basis when he or she does your annual tax return (this presumes you are filing on a cash basis, which is consistent with most small and emerging businesses). In very simple terms, all the CPA needs to do is remove the accounts receivable and accounts payable balances from the balance sheet with off-setting entries on the profit and loss statement to convert accrual books to cash books. It can be more complicated, which is why you want to have a very good tax CPA on working for you.

Businesses that use Quickbooks may be aware of the ability to switch between cash-basis and accrual-basis books by modifying the profit and loss or balance sheet. In essence, all Quickbooks does is remove the AR and AP from the balance sheet with off-setting entries on the P&L. In a perfect world, that works, but Quickbooks-users will often find balances still show up in those two balance sheet accounts after switching to cash-basis. This is a common problem that can be a little complicated to fix, but there are some good instruction on the web if you google it.

If you are serious about understanding and improving performance, then accrual accounting is going to help you obtain the clarity you need to maximize your efforts and accomplish your goals and objectives.

Great post.  I completely agree with the need for business owners to use accrual accounting to accurately measure performance.  Without accrual accounting it becomes difficult to match income and expenses to accurately analyze items such as sales margins.  As you know, it is an education process for the non-accounting types to understand accrual accounting.  An important part of converting from cash to accrual accounting is process changes.  For example, I see many business owners that stick their vendor invoices into a file folder and don't enter it until it is time to pay.  Getting in the habit of immediately entering information into the system will pay long term benefits for those business owners that want to get to more real time reporting and decision making.

- Scott Grossfeld, CPA, CFE