What is the Difference between Cash and Accrual Accounting?
Cash and Accrual Accounting are the two principle methods of reporting financial statements. The basic differences are related to the timing of when the income and expenses are accounted.
Here is a simple explanation of Cash Accounting:
Cash Accounting accounts for income at the time payments are received. Accounts for expenses at the time the bills are paid.
Here is a simple explanation of Accrual Accounting:
Accrual Accounting accounts for income at the time the service was performed (or product is shipped). It accounts for expenses at the time the expense was incurred for operational expenses, as well as accounting for cost-of-goods at the time the service was performed (or product was delivered).
Cash Accounting is the simplest method of accounting, as it only requires knowing when the money leaves the bank or is deposited into the bank. However, Cash Accounting tells you less little about the actual business performance/profitability, as pent-up unpaid bills are not apparent on a cash P&L.
2. Since my taxes are done on a cash basis, do I need to do accrual accounting?
Your CPA may opt to submit your business taxes on a cash accounting basis, which is completely fine and may be in the best interest and most appropriate for your business. Usually, we recommend that your financials still be captured and managed on an accrual accounting basis. This gives the business more flexibility to report on either an accrual or cash basis. And, accrual accounting gives a more accurate picture of true business profitability by period. Also, as businesses grow, investors, banks, and auditors will typically want to see accrual based financial statements, for current as well as historical periods.
It is pretty straight-forward to switch from accrual to cash for tax return purposes. This is a reporting ‘toggle’ in QuickBooks, along with some known typical adjustments (e.g. Inventory AR isn’t completely reversed with this toggle). VBS can help you implement accrual accounting principles as well as ensuring your CPA will be comfortable with the cash-basis reporting at end of year.
3. How important is being GAAP compliant to our business?
Initially, a business may feel like GAAP (Generally Accepted Accounting Principles) financials are too much work (and cost) and have little value for their business. Initially, you may be right. But, we would recommend that a business consistently ‘grow toward GAAP’ as a financial philosophy.
For example, payroll accruals may be ‘overkill’ for a very small firm with a few days of month-end payroll overlap, and not outside financial reporting requirements. But, as the firm grows, this month-end pay overlap might become more material to the monthly profitability. And, investors, banks, or auditors may want to see true profitability considering the payroll liability outstanding.
So, in anticipation of this, we would encourage the small business to consider adding GAAP analysis and adjustments, one at a time, as their business grows.
4. Is QuickBooks® sufficient for a public company and/or is it Sarbanes Oxley compliant?
We often hear “we want to go public so we need to move off of QuickBooks”. Yes, it is true that most public companies use very extensive, complex (and expensive) systems to support their businesses. But, the rules around Sarbanes Oxley and public companies are not specific to systems or applications, they are specific to controls and processes.
Vector Business Solutions has public clients that are running on QuickBooks Enterprise. These companies have simpler financial needs that can be currently met with QuickBooks Enterprise and external controls and processes. Undoubtedly these companies will be looking at more robust systems in the near future, but they were able to go public using their current systems. VBS doesn’t provide public accounting services, but we do provide the QuickBooks knowledge and support to help the public company’s Finance department use QuickBooks to support their needs.