Cash flow versus accrual accounting what's the difference one of the biggest issues when it comes to small business is how to account for money that flows through and out of your business in this video i will talk about the two methods that are utilized which are cash accounting and accrual accounting and touch on some of their major differences .
And how they're utilized depending on what type of business you own deciding which one you utilize is up to your business type and both have their own advantages and drawbacks welcome back to my channel mystery money this is your first time here my name's nick and on this channel i tackle all sorts of topics that .
Surround money if you're returning thank you again for taking the time to watch another video before we get started on the topic of accounting could you do me a favor and account for you visiting my channel by clicking on that like button making sure it turns blue i would greatly appreciate it as it .
Helps out the channel a ton and gets this information out to the people that need it most thank you very much for that now let's get started full disclosure i am not an accountant i specialize in finance and if you want to know the difference check out this video here if you have a specific question .
Concerning the methods that i'm about to talk about talk to a professional who specializes in this field and if you currently know what type of accounting you use let me know in the comments type cash accrual or just leave a question mark if you're really not sure so what does either term mean .
Well cash accounting is pretty much straightforward you record transactions when cash exchanges hands this method is kind of misleading nowadays since most of the transactions are in the form of records or digital transactions versus cash but it'll still work for this example .
If you use the cash accounting method you would record a payment when you receive payment this type of accounting is best for small businesses and the ones that don't have inventory once you add inventory this changes how you need to account for sales to break it down if you sell a service such as consulting .
And you charge 20 at the end of your consulting session the client pays you 20 you would record that in your records this is the most basic method since you're not having a lot of buckets that money will go in and out of your cash flow is pretty straightforward and easy to understand .
Your lender your investors can see what money you have left at the end of each month to pay your bills or continue operation this is the method that i use in our trucking business we pay our employees and all of our bills throughout the month and only receive payments twice a month depending on when those .
Checks hit our account the business may not look profitable we could change uh to the next method which i'm going to talk about but i feel like it would be way more work and who needs more of that the next method is accrual accounting with accrual accounting the cash flows are completely different if you utilize the .
Accrual method and let's say you give your client 30 days to pay your bill you would account for that sale the day that it was made but instead of that 20 dollars going into your operating account that 20 would go into what's called accounts receivable once the customer actually pays you the money .
It would move from accounts receivable to cash in your account where this gets confusing is when you look at the cash flow of your business and whether your business is profitable or not when you utilize accrual method your expenses are realized mostly in one month take utilities rent insurance and any .
Other miscellaneous expense you pay these throughout the month these will all hit your bottom line and count against your cash flow if you are giving different terms or ways that your customers can pay let's say 20 days 15 days 30 days that cash flow may not be realized in the same month this is going .
To lead to a negative cash flow so what do you need to do if you use accrual accounting you're going to have something prepared called a cash flow statement or a statement of cash flows this would take into consideration all of the cash and cash equivalents that the business anticipating in any given .
Month the cash flow statement measures how well a company manages its cash position the cash position means how well the company generates cash to pay its obligations and fund its operating expenses the cash flow statement complements the balance sheet and income statement and is a required part of the .
Company's financial reporting creditors like banks can also use the cash flow statement to determine how much cash is available this is referred to as the company's liquidity basically the funds that are available to operate the expenses and pay the debt the main components of the cash flow statement .
Are cash from operating activities from investing activities and cash from finance activities the operating activities on the cash flow statement include all sources of cash from the business activities in other words it reflects much of the cash that is generated from companies products or sales some of the other type .
Of operating activities would be things like receipts from sales of goods and services interest payments income tax payments payments made to suppliers or goods and services used in production salaries and wage payments to employees rent payments and any other types of operating expenses .
Cash flow from investing activities investing activities include any sources and uses of cash from a company's investments that would be things like purchase or sale of an asset loans made to vendors or received from customers basically anytime changes are made to equivalents like sales or purchases they would fall under investing .
Activities then you have cash from financing activities cash from financing activities these would include sources and uses such as cash from investors or banks as well as uses of cash such as paying shareholders payments of dividends payments of stock repurchases and repayments of debt principle these are .
All included in this category there's a whole lot more information about the different categories and i'll put a link to my sources that you can check out when you can accrual accounting is considered the standard accounting practice for most companies except for very small businesses and .
Individuals the internal revenue service allows qualifying small businesses that have less than 25 million dollars in annual reviews to choose which method they want to use the accrual method does provide a more accurate picture of the company's current condition but it is somewhat complex and can make it expensive for .
Both implementation and to maintain accrual accounting also claims that the cash method i talked about earlier is not accurate because it is likely that the company will receive cash at some point in the future because the services have been provided the cruel method recognizes the revenue when your .
Clients services are conducted even though the cash payments haven't hit your bank account the more complex your bookkeeping the more expensive it may be for your accountant to file your taxes or even keep your books at the end of the day no matter which method you choose it's always a good idea to have a good .
Set of financial records it's much easier to obtain a loan get an investor to take a look and have an understanding of where you are making money this way you can tell whether you're making money or if you're just paying for a job i hope you gained a better understanding .
Of these types of accounting methods and if you have any questions let them in the comments below if you are an accountant and i missed anything please post that as well so maybe some others can learn from your expertise thanks again for taking the time to watch this video i truly appreciate it and until next time .
Have a great day