Your choice of accounting system can make a big difference to your ecommerce business. Choosing the right one is crucial for managing everything from cash flow and taxes to data storage.
Cash and accrual accounting are two of the most popular systems. While they may seem similar, there are some important differences. So, how do you find out which one is best for your business?
Our article looks at cash vs accrual accounting. We’ll walk you through each accounting system, how it works, and the things to consider when picking one for your business.
How cash accounting works
Cash accounting is a very straightforward way to record incomings and outgoings as they happen. Let’s see how it works:
Only recognizing money in the account
Cash accounting happens in ‘real time’ so you don’t consider pending transactions. You only recognize revenue when it hits your account and not before.
Let’s say that you send an invoice to a client for $100. The invoice arrives in July, but the client doesn’t pay until August. Under a cash accounting system, you would log this payment as August revenue. In fact, you would count it as an August payment even if you’d originally invoiced as far back as January.
Tracking your finances by payment received offers a more straightforward way to do bookkeeping. You can simply compare your bank statements against your books by looking for dates.
Tracking expenses as they clear
Similar to payments, you don’t log expenses until the money has left your account.
So, if you receive a shipment of materials in July but don’t pay for it until a month later, you would log that payment as an August expense.
Keeping accounting simple
Cash accounting is very popular with sole proprietors and small businesses due to its simplicity. Because you have fewer payments to consider, it’s easy to track funds through the ledgers. And if you enable transaction IDs, you can simply check when money left or arrived in your accounts.
As it’s simpler to use, cash accounting is also relatively easy to implement. It has a shorter learning curve than accrual accounting, so you’ll have a smoother start to running your business. You’ll also find it easier to train new members of your team about how to do the books.
Monitoring cash flow in real time
Cash accounting lets you monitor your cash flow in real time. This is essential if you need to know how much money is available to you right now, not in the future.
If you use expense and time management software alongside your cash accounting system, you can just glance at your books and be able to know how much you have. You can also integrate these platforms with your billing and invoicing systems to minimize errors.
Having this degree of oversight is useful if you’re a smaller business that may not have a ‘buffer’ of cash to tide you over when your budget is tight. For example, when you have an unexpected expense like a product recall, it doesn’t make a difference if you have payments coming next month – you need the money upfront.
Cash accounting can clarify your cash flow situation and help you to manage your cash flow more effectively.
How accrual accounting works
Accrual accounting provides a better overall picture of a company’s finances than cash accounting, but is a more complicated system. Here’s how it works:
Recording payments instantly
With accrual accounting, you record ingoings and outgoings as you do the paperwork rather than when the transfers happen.
For example, say you invoice a client in July, but they don’t pay the invoice until August. You would still record the transaction as July income. Likewise, if you receive a bill in October but don’t pay until November, you would still count this as an October expense.
Getting an accurate idea of your financial health
Accrual accounting provides a much more holistic and accurate measurement of a company’s financial health and performance. On top of this, GAAP regulations state that any company with annual sales revenue of more than $25 million uses this method.
For example, a company may have just made a huge investment that left them with just $1 million in the bank. But they’ve only been able to make this investment because they have $100 million pending in accounts payable.
A cash accounting system would record that company as having just $1 million in revenue, which could lead to undeserved tax breaks. But with accrual accounting, the $100 million in accounts payable would be recognized, and the tax breaks wouldn’t be offered.
That’s why tax authorities make accrual systems mandatory to ensure companies pay the right amount and don’t receive benefits they shouldn’t.
Making long term financial decisions
While cash accounting is more suitable for managing day-to-day cash flow, the accrual system is much better for long-term financial planning.
Accrual accounting gives a clearer picture of your overall income and expenses during a given time period. Rather than focusing just on cash flow, businesses can track their finances over time and compare it more easily to market fluctuations. They can also tell whether a sudden surge in sales is due to an upturn in the economy or their business strategy.
This extra context allows business owners to look further than the next invoice. With accrual accounting, you can dig deeper into consumer spending habits and create detailed financial strategies for the future.
The tradeoff is that accrual accounting can be much more complicated to manage. However, advanced financial management and planning software can simplify bookkeeping with features such as automation, scalability, ERP integration, and compliance.
What to consider when choosing between cash and accrual accounting for e-commerce
Here are some factors to consider when considering cash vs accrual accounting:
The size and expansion stage of your ecommerce business
Generallycash accounting is ideal for smaller businesses due to its simplicity and focus on short-term cash flow. Accrual accounting is better when large businesses with the scope for long-term investments and detailed financial planning.
Ecommerce accounting software support
The bookkeeping software you use may be more suited to different kinds of accounting. For example, your POS and sales processing platform may have settings that allow you to record revenue when you invoice.
Good ecommerce and accounting software has features for both cash and accrual accounting. It should also be able to switch easily between the two as your business needs change.
It’s worth considering which system will work best with your current tech stack, so you can work out whether you need to change or add platforms to have the best setup for your company.
Long term goals
Accrual accounting scales very easily, whereas the cash system doesn’t. As businesses grow, they’re more likely to handle complex payments, which cash accounting can’t represent well. You may get a misleading impression of how much revenue you’ve made if you’ve made many wise investments, but you can only see your immediate outgoings.
Similarly, while cash accounting can help you maintain a tight budget during tough times, it’s harder to use for longer-term planning. You only get a fixed impression of your financial health and can’t see the ups and downs that occur throughout the year.
So, if you’re in a fast growth stage, it’s definitely worth considering whether you need to switch to a more scalable form of accounting.
Tax filing and reporting
Both systems have advantages and disadvantages when it comes to taxes, especially in terms of scheduling. If you file at certain times, the different systems could bring you benefits.
For example, if you issue an invoice in one tax season but it isn’t paid until the next tax season, that revenue you wouldn’t need to count that money in your tax return. You can use accrual accounting here to schedule payments in ways that benefit your cash flow.
On the other hand, accrual accounting could show a large amount of taxable revenue due to accounts payable when your funds are very low. This can cause problems when you get a big tax bill before those payable accounts are fulfilled.
Data management and analytics
Accounting data can take up a surprising amount of space, so prepare sufficient storage on your devices. Also consider how suitable your platforms are for data analytics, as the right solution can make a huge difference to your workflow efficiency.
For example, effective purchase order management software could handle administrative tasks for you. It can not only store payable purchase orders for you, but it can also organize and analyze them to create detailed reports. With this information, you can check your accounts for issues more easily and make more informed decisions about your finances.
Similarly, ecommerce accounting integrations can make data management and analysis more efficient. You can ensure data is accurate and up to date across your different platforms so your reports are relevant. You can also filter the information so you don’t include too many confusing, extraneous details.
Ease of implementation and upfront costs
If you’re just starting out, you’re probably on a tight budget and need to invest all your time into the business. In this case, cash accounting could suit your needs better as it’s simpler, so you won’t have to spend time learning or have to hire a bookkeeper. You also won’t need extensive software with high subscription fees to manage it.
On the other hand, if you’ve got some prior knowledge of bookkeeping or some resources, you might find implementing accrual accounting is a worthwhile investment of your time and money.
Cash vs accrual accounting: Which suits you best?
Cash accounting and accrual accounting both have advantages and disadvantages. Your choice should depend on your business needs and your preferences, not to mention your local labor laws.
It’s worth considering which system to use when your decision could have a profound impact on your business. Your choice could be the difference between costly errors and extra time on bookkeeping or taking your ecommerce store to new heights.