When managing your small business in Australia, you’ll come across the terms “cash” and “accrual” on various forms from the Australian Taxation Office (ATO).
These terms refer to the two primary accounting methods that businesses can use to report income and expenses.
Understanding the difference between cash and accrual accounting is essential because the method you choose can affect your tax obligations, cash flow, and overall financial management.
Cash Accounting Method
What is it?
The cash accounting method is straightforward and often preferred by smaller businesses, especially those with simpler financial structures.
With cash accounting, you record income when you actually receive it, and you record expenses when you actually pay them.
Example:
If you send an invoice to a customer on July 1st but don’t receive the payment until July 15th, with cash accounting, you would record the income on July 15th when the money actually lands in your bank account. Similarly, if you receive a bill from a supplier in June but don’t pay it until July, you record the expense in July.
Advantages:
- Simplicity: It’s easier to understand and manage because it directly reflects your cash flow.
- Tax Timing: You only pay tax on money you’ve actually received, which can be helpful if your clients are slow to pay.
- Real-Time Tracking: You get a clear picture of how much cash you have on hand at any given time.
Disadvantages:
- Not Always Accurate: Since it only accounts for cash that has physically moved, it might not give you a full picture of your financial obligations.
- Not Suitable for Larger Businesses: As your business grows, you might find that cash accounting doesn’t provide the detailed financial information you need.
Accrual Accounting Method
What is it?
The accrual accounting method records income and expenses when they are earned or incurred, regardless of when the cash is actually received or paid.
This method is often used by larger businesses or those with more complex financial situations.
Example:
Using the same example as above, with accrual accounting, you would record the income from the invoice on July 1st, the date you sent it, even if you don’t receive payment until later. Similarly, you’d record the expense on the date you received the bill, not when you actually paid it.
Advantages:
- Accuracy: Provides a more accurate picture of your financial situation, as it includes all income and expenses when they are earned or incurred.
- Better Business Planning: Helps in better forecasting and financial planning since it accounts for all financial obligations and earnings.
- Compliance: Certain businesses, especially those with a higher turnover, are required by law to use the accrual method.
Disadvantages:
- Complexity: It’s more complicated to manage and understand, especially if you’re not familiar with accounting principles.
- Cash Flow Management: Since you’re reporting income before you actually receive it, you might end up with a tax bill before you have the cash to pay it.
Which Method Should You Choose?
The choice between cash and accrual accounting depends on the size and nature of your business. Many small businesses prefer cash accounting because of its simplicity and real-time reflection of cash flow.
However, as your business grows or if your financial situation becomes more complex, accrual accounting might be more suitable.
In Australia, businesses with a turnover of less than $10 million can generally choose between cash and accrual accounting for GST purposes. It’s a good idea to consult with an accountant or financial advisor to determine which method best suits your business needs.
At Oculus Group we are only too happy to guide you on which method is best suited to your business situation and to answer your questions. Contact us today to book an appointment with one of our friendly accountants.
