Should You Use Accrual Accounting?

Today, we’re looking at a topic that can be confusing: accrual accounting.

Accrual accounting is one of those accounting terms that gets tossed around, but if you’re running a business and want to make sound financial decisions, it’s essential to understand what it means and why it might be the best choice for your business.

Cash vs. Accrual Accounting – What’s the Difference?

Let’s start with the basics. Most small business owners, especially those just getting started, often file their taxes using cash basis accounting. It’s straightforward – when you receive money, you count it as income, and when you spend money, it’s recorded as an expense. Simple, right? It tracks the actual flow of cash in and out of your business, which makes it a great tool for understanding cash flow.

However, there’s another option: accrual accounting. It’s a bit more complex but offers a more accurate picture of how your business is really performing.

Instead of only recording income when cash hits your bank account, you record income when you’ve earned it – even if you haven’t been paid yet. Similarly, you record expenses when you incur them, not just when you pay them.

Here’s an example: Imagine you’re a coach offering a 12-month program. Some clients pay monthly, and others pay upfront for a discount. If someone pays upfront in January, you’d receive all the cash at once, but that money is meant to cover your services for the entire year. With accrual accounting, you spread that income over the 12 months, recording revenue as you actually provide the service. This helps give you a more consistent picture of your monthly performance.

Why Accrual Accounting Matters

At first glance, cash accounting might seem like the easiest way to go. But here’s the catch: cash flow doesn’t always reflect the full story of your business’s financial health. If you’ve been paid for a year’s worth of services upfront, it can look like you’re flush with cash one month, only for it to seem like you’re struggling the next because you haven’t been paid again.

With accrual accounting, you get a clearer picture of your profitability month-to-month. This method aligns your income with the time period you’re actually earning it, which is crucial for making informed decisions about pricing, services, and even hiring.

When Should You Use Accrual Accounting?

If you’re running a small, straightforward business, cash accounting may still be the best fit for you. But once you hit a certain level – say, over six figures in revenue – it’s time to seriously consider accrual accounting.

Here are a few reasons why:

More Accurate Financials: Accrual accounting gives you a better understanding of your business’s overall financial health, not just how much cash you have on hand at any given moment.

Smoother Cash Flow: It evens out your income and expenses, so you don’t experience the highs and lows that come with upfront payments or delayed expenses.

Easier Business Planning: With accrual accounting, you can make better decisions about your business. Should you offer discounts for upfront payments? Do you need to raise prices for certain services? Is now the right time to hire?

Working with the Right Financial Professionals

As your business grows, managing your finances on your own can become overwhelming. This is when outsourcing to financial professionals becomes critical. Here’s a quick breakdown of who you might need on your team:

Bookkeeper: By far the first hire you should make once your business hits six figures. They’ll handle the day-to-day financial tasks, ensuring your books are accurate and up to date.

Tax Preparer: This is someone you’ll want for your annual tax filings. They’ll make sure everything is filed correctly, but they aren’t necessarily thinking ahead about how to save you money in the future.

Tax Strategist: Once you hit six figures, working with a tax strategist is a game changer. They’ll proactively work with you throughout the year to create tax-saving strategies so you can keep more of your hard-earned money.

CFO (Chief Financial Officer): This one’s for larger businesses, typically those bringing in seven figures or more. A fractional CFO can help you make big financial decisions, from cash flow management to scaling your operations.

Ready to future-proof your business?

Accrual accounting may seem intimidating at first, but it can be a powerful tool for understanding your business’s financial health. It helps you see beyond the day-to-day cash flow, giving you a clear picture of how profitable your business is in the long term. If you want to learn more about how to better your business’s financial health so you can future-proof your business, tune in to Episode 71 of the CEO Moms Building Wealth Podcast.

Disclaimer: This article is not meant to be tax advice. This is not an all-inclusive list of business advice. Different rules may apply to each individual taxpayer’s specific situation. Please consult with your accountant. May contain affiliate links.