You might have heard the terms “cash basis
accounting” or “accrual accounting.”
Your net income number can change depending on which method your books
are set up for. Here’s a simple
explanation of the difference, with a little help from one of the most famous
cartoon characters in history.
Popeye
and Wimpy
You might recognize Popeye the Sailor Man from the
television cartoons or other media. His
sidekick, Wimpy, was the one who was always hungry and always out of cash. One of his favorite sayings was, “I’ll gladly
pay you Tuesday for a hamburger today.”
It’s
All in the Timing
Let’s make today Thursday. If Wimpy wants to pay us Tuesday for a
hamburger today, here’s how it would be done for a restaurant on cash basis: Cash
basis recording Wimpy’s hamburger purchase Both the sale and the receipt of cash would be
recorded on Tuesday. Companies on cash
basis only record the transaction when the cash is received. But, if the restaurant’s books were on the accrual
basis, it would be a different story: Accrual
basis recording Wimpy’s hamburger purchase Wimpy’s hamburger sale would be recorded on
Thursday, the day he ate the hamburger. The receipt would then be recorded on Tuesday,
assuming Wimpy made good on his promise to pay. You might be asking why a few days is such a big
deal. Outside of cartoon life, a couple
of extra twists can happen. It can be
far more than a few days from the time you do the work to the time you get paid
for it. And often, these dates span
different months and even years, affecting the amount you have to pay in taxes
to various agencies. Manipulating these
dates (legally, of course) is one of many tax planning strategies that we can
help you with.
Choosing
for Your Business
In many cases, the government has chosen which
method you must use when it comes to sales tax, payroll taxes, and income
tax. That’s part of the reason we make
the required adjustments to your books at year end. To help you run your business in a forward-thinking
way, the accrual method is best. You can
record invoices for work you’ve done even though you haven’t received payment
yet. You can enter bills you need to pay
before you pay them to forecast cash requirements. Using accrual accounting, you can budget for
cash flow needs as well as see more accurately what your revenue and income is
looking like. For clients who remain behind in their bookkeeping
and just want to catch everything up once a year, the cash basis is
adequate. However they lose out on all
the good information they could have had throughout the year to run their
business better. For other businesses, a hybrid approach between cash
and accrual accounting can be the most cost effective.
A
Little Help from Popeye the Sailor
What would Popeye say about all this accounting
talk?
"That's all I can stands, cuz I can't stands
n'more!"
