Getting the full financial picture of any company is like solving a math problem written in an unfamiliar language. It can be quite complicated and even confusing at times. But that just proves that proper accounting is essential in keeping track of your company’s financial health.
There are two standard methods of business finance accounting for eCommerce businesses: the cash method and the accrual method. These methods are quite different from each other, which is what we’ll be exploring today.
What is cash accounting?
The cash accounting method tracks your income the moment you receive it and not a minute earlier. The same goes for your expenses. Whenever you pay for any expense, that’s the time the expense is reported. If you’ve ever balanced a personal chequebook or recorded what you’ve spent and earned in a spreadsheet, then you probably have adhered to a similar set of guidelines.
To better illustrate what cash accounting is, here’s an example:
You’re the owner of a business that supplies a smoothie bar with custom disposable cups and straws every month. It’s the middle of September, and you already sent out your client’s supply for the month of October. You won’t get paid until the end of October, so that income will only be recorded in October’s books. If your client never pays, then the income is never recorded.
What are the advantages of cash accounting?
The cash accounting method tracks real-time transactions, meaning everything is recorded as they happen and only when cash changes hands. If you’re a small business and you want to monitor precisely how much cash you have on hand, this method is a good fit for your business. It allows you to be more mindful of overspending.
There’s also a tax benefit to using this method. Since transactions aren’t recorded until cash is received or paid, you won’t be taxed until that money is in your bank.
What is accrual accounting?
The accrual method takes more of a hypothetical approach to your finances. An eCommerce accountant will record income when it is billed and the expenses when they arrive. Unlike the cash method, accrual accounting records the client invoice the day it is received, even if you don’t get paid for it until a month later. Accountants typically use a balance sheet to record the offsetting assets and liabilities so that you can maintain a good sense of your business’s current financial position.
Here’s a quick and easy example of the use of accrual accounting:
It’s still September, and your smoothie bar client orders a supply of custom disposable cups for the following month. The income you get from that order is immediately recorded as revenue even if you don’t get paid until October.
What are the advantages of accrual accounting?
Since this method records transactions upon completion of a delivery or service and not when cash changes hands, you get a clearer picture of your business’s profitability, especially in the long term. You have the ability to make predictive decisions, and a better sense of your cash flow needs as well as any outstanding expenses that are due.
Conclusion
Both accounting methods have their own pros and cons, and it really depends on the size of your business or the industry you’re in. Going cash-based is better if you have a healthy amount of cash flow to go with, but it gives a false image of profitability. On the other hand, accrual evens out your earnings and gives you a bigger picture of your finances. The bottom line is each method only shows a part of your company’s financial health.
If you need the help of experts in managing your finances, turn to the Ecommerce Accountant. Whether you’re selling a product or providing services, our business advisors can help you make better sense of your finances. We are an online accounting firm with a passion for all things eCommerce. Partner with us today!