Cash vs Accrual Accounting: An Essential Explainer for Entrepreneurs
Cash basis accounting and accrual basis accounting are the most common accounting methods used by businesses to keep track of their revenue and expenses. However, companies prefer one method to the other depending on their business model. Entrepreneurs need to determine which one of the two is ideal for their business model for which accounting firms in Dubai can offer guidance.
If you want to determine the right accounting method for your business, you need to learn about its core differences. Read ahead to know the key differences between Cash and Accrual accounting:
Cash vs. Accrual Accounting
The timing of when revenue and expenses are recognised determines the core difference between the two accounting approaches. In the cash accounting method, the revenue and expenses are recognised only on receipt of cash. On the other hand, the accrual accounting method focuses on anticipated revenue and expenses.
What is Cash Basis Accounting?
Businesses using cash basis accounting recognise income and expenses only when money changes hands. In this method, you will not count sent invoices as income or bills as expenses, until they are settled. The cash basis accounting method does not recognise accounts receivable or accounts payable. It is simple and easy to maintain and shows the amount of money you have on hand at a given time.
When To Use Cash-Basis Accounting?
Certain types of businesses are especially fond of the cash-basis accounting method. They are:
1. Sole Proprietors and Small Businesses
These types of businesses are frequent users of cash-basis accounting, as it is simple and easy to use. Professionals such as audit firms, lawyers and doctors use cash accounting system or Mixed accounting system (Professional Fees are accounted on a cash basis and expenses are accounted on an accrual basis).
2. Businesses Operating Without Inventory
Companies with inventory do not use the cash accounting method as it focuses on the flow of money rather than tracking the movement of inventoried goods. However, businesses without inventory do not face this issue and they prefer the cash-basis approach.
3. Cash-Only Businesses
Nowadays, most businesses use debit or credit cards. However, companies that do not want to worry about credit-related liabilities may use the cash-basis accounting method.
What is Accrual Basis Accounting?
In this approach, businesses recognise income as soon as they raise an invoice for a customer. When they receive a bill, they will recognise it as an expense even if payment will not be made for another 30 days. With this approach, businesses can get a much more accurate picture of their performance finances.
Businesses that follow the accrual accounting method will be able to make financial decisions with more confidence. It will also enable you to pitch for long-term finance easily. Accounting companies in Dubai can advise you whether this approach is ideal for your business.
When To Use Accrual-Basis Accounting?
Accrual accounting is mostly used under the following circumstances and most importantly accrual base accounting is only recognized by the IFRS (International Financial Reporting Standards).
1. When Your Business is Large
Larger businesses adhere to this approach as they are likely to have too many moving financial parts. In addition, they cannot rely on a cash-basis approach to manage them.
2. When Accepting or Making Credit Card Payments
Cash payments can be accounted for quickly but it will take some time for credit-based statements to arrive. Moreover, such payments can post days or weeks after the transaction initially occurs.
3. Tracking Assets and Liabilities
Not only the cash on hand but cheques, short-term investments and inventory are also considered assets. In the same vein, an unpaid expense will be treated as a liability, acknowledged before bills get paid rather than after payments are sent. With the accrual approach, it will be easier for you to distinguish assets and liabilities by keeping up-to-date records of what items fall into either category and for how long.
Hire the Best Accounting Companies in Dubai, UAE
You need to choose the right accounting method depending on the business model. Accounting firms in Dubai such as Jitendra Chartered Accountants (JCA) can advise you on the accounting method ideal for your business. When it comes to accounting services in Dubai, we are the leaders in the industry. JCA has more than 21 years of experience in the industry, serving companies in a diverse range of sectors.
Irrespective of what type of business industry you are in, we can prepare your financial statement accordingly and maintain your books of accounts as per international standards. Apart from offering accounting services in Dubai and across the UAE, we provide other services such as VAT, AML-CFT compliance, Corporate Tax, Economic Substance Regulations (ESR) filing Ultimate Beneficial Ownership (UBO) filing etc. Contact JCA today for availing our robust accounting solutions.