Why is understanding accrual and cash accounting methods important for business owners, particularly for owners of small businesses? Many small businesses are used to using a ‘cash in cash out’ form of accounting, very similar to the format of bank statement, so why should they consider anything different.

It’s all got to do with knowing how well your business is doing month in month out, and just about how much spare cash you have in the bank at any one time. In order to operate a business properly, it is important that you can compare each month on an equal footing. This is an important factor in analyzing whether you are improving during the course of the year or whether you need to take some action to improve the way your business is operating.

Problems with Cash Accounting

You can do that by checking your bank balance! That’s where understanding accrual and cash accounting methods becomes important. With a cash system, every time you get paid by a client or customer you mark it as a credit, and every time you make a payment to your workforce or for raw materials you mark it as a debit. Money in – money out; it seems a simple way to keep your accounts, and so it might be – as long as you have no extraordinary expenditure in any month.

How about if you offer credit, as most businesses do? You might incur the expenses for the work or the product one month and not get fully paid for another few months. How about your annual business insurance: will you pay all that in one month and maybe end up making a loss that month because of your cash accounting system.